What are Prepaid expenses? How to record prepaid expenses?

Prepaid expenses

Business expenses are simply the necessary cost to run a business smoothly. There are different types of business expenses out there. Having detailed knowledge about different expenses that your business incurs can help understand the financial health of your business. It is also necessary to track and categorize your expenses to scale your business performance.

What are Prepaid expenses?

Prepaid expenses are when you make the payment in advance for goods or services that will be delivered in the future. The benefits of these products or services will be acquired in the future. The payment of these goods or services will be made in the current accounting period but the delivery won’t be.

Examples of Prepaid Expenses

  • Employee’s Insurance policies
  • Company insurance policies
  • Taxes
  • Leased office equipment
  • Advanced rent payments
  • Any payments that are made in advance

How to record prepaid expenses?

According to Generally Accepted Accounting Practices, prepaid expenses are recognized as a current asset section of the balance sheet and these expenses should be recognized in the same accounting period as the payment is made. This means even though you made payment for your expenses upfront, they won’t be treated as expenses yet. The payment will be recognized under the current asset until it’s the benefits of the item are fully acquired. If it takes more than 12 months, it will be classified as a long-term asset. Once it is fully acquired, then it won’t be treated as a current asset anymore. It will be reported as an expense on the income statement of that specific accounting period.

Here is an example of prepaid expenses are recorded

If a company purchases a yearly insurance policy for $12000 and it is paid in advance. The monthly premium of the insurance is $1000 for a year. The initial $12000 will be recognized as a current asset. The monthly premium of $1000 will be deducted from the balance sheet and will be shown as an expense in the income statement. By the end of the 12th month, you will receive full benefits of your expense will be received and the amount on your balance sheet for that specific expense will be zero and payment will be recorded as an expense on the income statement.

Date Entry Amount Amount
01/01/2022
Prepaid Insurance (Dr)
12000
Bank A/c (Cr)
12000
31/01/2022
Insurance Expenses (Dr)
1000
Prepaid Insurance (Cr)
1000

On each month for a year, Insurance expenses will be recorded on the income statement as an expense.

Categorizing and managing different kinds of expenses can be very hard. At Agile e-Platform, we help all kinds of businesses with accurate accounting services that will improve your financial health. Reach out to us to know more.

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