Prepaid Expenses – Accounting Superpowers

Prepaid Expenses

Prepaid Expenses

As the name implies, Prepaid Expenses represent a prepayment for a future expense.

They are classified as Assets in a company balance sheet since they relate to expenditures which have some future economic benefit to the company.   

For Example,

  • Rent paid upfront is a prepaid expense which allows the company to utilize a premises for many months into the future.
  • Insurance policies (Property, Fire etc.) are typically paid upfront and can be enforced for many months into the future.
  • Magazine Subscriptions.
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    Retainers paid to Law Firms or marketing agencies. 

Typically, Prepaid Expenses which will expire within one year from the balance sheet date are listed in the current assets section of the Balance Sheet.

As the prepaid expense expires in a given accounting period, accountants record a journal entry for the expiration as an expense.

Technical Stuff

Journal Entry for recording a Prepaid Expense.

On January 1, Superpower Inc, paid $3,000 for a one year insurance policy.  

The transaction causes an increase in an asset (Prepaid Insurance) and a reduction in another asset (Cash).  

The Journal Entry would be 

Jan 1. Prepaid Insurance Debit                         $3,000

         Cash Credit                                                       $3,000

At the end of Jan, one of the twelve months paid for the insurance have expired. So, an entry needs to be made to reduce the prepaid Insurance amount.  The amount to be reduced is $250 ($3,000/12) and the entry is

Jan 31st    Insurance Expense Debit                         $250

                    Prepaid Insurance Credit                            $250

The Insurance Expense would now be shown in the income statement for January and Balance Sheet prepared for Jan 31st would show the Prepaid Insurance amount or $2,750.

As the insurance coverage expires over multiple future periods, a series of subsequent entries such as the one above are made.


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