Prepaid expenses are payments for goods or services that will be received in the future. These expenses are not initially recorded on a company’s income statement for the period when the money changes hands.

Instead, prepaid expenses ar🍒e first recorded on the balance sheet as an asset. But, as the products and services are received, prepaid expenses are recognized on the income statement for each period when the money is spent.

What Are Prepaid Expenses?

澳洲幸运5官方开奖结果体彩网:Prepaid expenses are payments made for goods and services that a company intends to pay for i♛n advance but will incur sometime in the future. Examples of prepaid expenses include i🌼nsurance, rent, leases, interest, and taxes.

Prepaid expenses aren’t included in the income statement per 澳洲幸运5官方开奖结果体彩网:generally accepted accounting priꩵnciples (GAAP). In particular, the GAAP matching principle requires 澳洲幸运5官方开奖结果体彩网:accrual accounting, which stipulates that revenue and expenses must be reported in the p🗹eriod that the spending occurs, not when cash or money exchanges hands.

In other words, expenses should be recorded when incurred. Thus, prepaid expenses aren’t recognized on the income statement when paid because they have yet to be incurred.

We’ve outlined the procedure for reporting prepaid expenses below in a little more detail, along with a few examples.

Recording Prepaid Expenses

When a company prepays for an expense, it is recognized as a prepaid asset on the balance sheet, with a simultaneous entry being recorded that reduces the company’s cash (or payment account) by the same amount. Most prepaid expenses 澳洲幸运5官方开奖结果体彩网:appear on the balance sheet as a current asꦐset unless the expense is not to be incurred until after 12 months, which is rare.

Then, when the expense is incurred, the prepaid expense account is reduced by the amount of the expense, and the expense is recognized on the company’s income statement in the period when it was incurred.

Insurance as a Prepaid Expense

One of the more common forms of prepaid expenses is insurance, which is usually paid in advance. This means that tꦕhe premium you pay is allotted to the up💯coming time period.

For example, Company ABC pays a $12,000 premium for directors’ and officers’ 澳洲幸运5官方开奖结果体彩网:liability insurance for the upcoming year. The company pays for the policy upfront and then, each month, makes an 澳洲幸运5官方开奖结果体彩网:adjusting entry to account for the insurance expense in𝓀curred. The initial entry, where we debit the prepaid expense account and credit the account used to pay for the expense, would look like this:

Then, after a month, the company makes an adjusting entry for the insurance used. The company makes a debit to the appropriate expense account and credits the prepaid expense account to reduce the asset value. The monthly adjustment for Company ABC would be $12ꦦ,000 divided by 12 months, or $1,000 a month. The adjusting entry at the end of each month would appear as follows:

Rent as a Prepaid Expense

Businesses may prepay rent for months in advance to get a discount, or perhaps the landlord requires a prepayment given the renter’s credit. Either way, let’s say⛄ Company XYZ is prepaying for office space for six months in advance, totaling $24,000. The initial entry is as follows:

Then, as each month ends, the prepaid rent balance sheet account is reduced by the monthly rent amount, which is $4,000 per month (𒈔$24,000 ÷ six months). At the same time, the company recognizes a rental expense of $4,000 on the income statement. Thus, the monthly adjusting entry would ap𒁃pear as follows:

Other Prepaid Expenses

Additional expenses that a company might prepay for include interest and taxes. Interest paid in advance may arise as a company makes a payment ahead of the due date. Meanwhile, some companies pay taxes before they are due, such as an estimated tax payment based on what might come due in the future. Other less common prepaid expenses might include equipment rental or utilities.

As an example, consider Company Build Inc.ꦡ, whiꦡch has rented a piece of equipment for a construction job. The company paid $1,000 on April 1 to rent a piece of equipment for a job that will be done in a month. The company would recognize the initial transaction as follows:

Then, when the equipment is used and the actu✨al expense is incurred, the company would make the following entry to reduce the prepaid asset acc൲ount and have the rental expense appear on the income statement:

Regardless of whether it’s insurance, rent, utilities, or any other expense that’s paid in advance, it should be recorded in the appropriate prepaid asset account. Then, at the end of each period, or when the expense is incurred, an adjusting entry should be made to reduce the prepaid asset account and recognize (credit) the appropriate income expense, which will then appear on the income statement.

The Bottom Line

At times, payments are made for future benefits. In accounting, these payments or prepaid expenses are recorded as assets on the balance sheet. Once incurred, the asset account is reduced, and the expense is recorded on the income statement. The GAAP matching principle, however, prevents these expenses from being recorded on the income statement before the asset is realized.