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Definition of Prepaid Expenses
A prepaid expense is an expenditure that is paid for in one accounting period, but for which the underlying asset will not be entirely consumed until a future period. When the asset is eventually consumed, it is charged to expense. A prepaid expense is also known as a prepaid asset.
A prepaid expense is carried on the balance sheet of the acquiring business as a current asset until it is consumed. The reason for the current asset designation is that most prepaid assets are consumed within a few months of their initial recordation. If a prepaid expense were likely to not be consumed within the next year, it would instead be classified on the balance sheet as a long-term asset.
An example of a prepaid expense is insurance, which is frequently paid in advance for multiple future periods; an entity initially records this expenditure as a prepaid expense, and then charges it to expense over the usage period. Another item commonly found in the prepaid expenses account is prepaid rent.
Expenditures are recorded as prepaid expenses in order to more closely match their recognition as expenses with the periods in which they are actually consumed. If a business were to not use the prepaids concept, their assets would be somewhat understated in the short term, as would their profits.
Prepaid Expense Accounting
The basic accounting for a prepaid expense follows these steps:
Upon the initial recordation of a supplier invoice in the accounting system, verify that the item meets the company's criteria for a prepaid expense.
If the item does meet the company's criteria, charge it to the prepaid expenses account. If not, charge the invoice to expense in the current period.
Record the amount of the expenditure in the prepaid expenses reconciliation spreadsheet.
At the end of the accounting period, establish the number of periods over which the item will be amortized, and enter this information in the reconciliation spreadsheet. This entry should include the straight-line amount of amortization that will be charged in each of the applicable periods.
At the end of the accounting period, create an adjusting entry that amortizes the predetermined amount to the most relevant expense account.
Once all amortizations have been completed, verify that the total in the spreadsheet matches the total balance in the prepaid expenses account. If not, reconcile the two and adjust as necessary.
A best practice is to not record smaller expenditures into the prepaid expenses account, since it takes too much effort to track them over time. Instead, charge these smaller amounts to expense as incurred. To extend this concept further, consider charging remaining balances to expense once they have been amortized down to a certain minimum level. Both of these actions should be governed by a formal accounting policy that states the threshold at which prepaid expenses are to be charged to expense.
Prepaid Expenses Example
A company pays $60,000 in advance for directors and officers liability insurance for the upcoming year. The journal entry is:
DebitCredit
Prepaid expenses$60,000
Accounts payable $60,000
At the end of each period, the company amortizes the prepaid expenses account with the following journal entry, which will charge the entire amount of the prepaid insurance to expense by the end of the year:
DebitCredit
Insurance expense$5,000
Prepaid expenses $5,000
Prepaid expenses are expenses that are paid in advance. Like for example prepaid rent, prepaid insurance, supplies and so on. You have to monitor and make an entry to record the unexpired/expired portion of these expenses every month or it depends on your report. The unexpired portion is recorded in the balance sheet and expired portion in the income statement.
Prepaid expenses means the amount expenses which is already paid or paid in advance, treatment for this in accounts it will comes in under Miss expenditure
Prepaid expenses paid for in advanve before the time they are normally pay forexamples are Rent, Lighting and electricty .
the Prepaid amount are recorded in the balace as Current assets
the philosophy of this method consist on the principle that every expense must be related to its profit for a same period. So, if for example you pay an insurance indemnity which cover a period from1/10/13 to31/01/14, you will book the3/4 of the indemnity amount the in P&L account (on31/12/13) as an expense as it's related to the year2013 and the1/4 of the amount as prepaid expenses that will be during the next year balanced with a P&L account and will be the expenses of2014 deducted from the income of2014.
Prepaid expenses is a kindl of current assets, and it relates to those expenses which are going to be reported into income statement in future, but currently they have not occurred as expenses. Prepaid expenses may relate to the period in future from one month to one year ahead.
As the treatment is concerned, when we pay an expese like rent we treat whole amount as prepaid at the time of recording it, they are a part of current assets, and listed in balance sheet, the portion which has been expired is deducted from this account and reported to expenses in income statement.
it is said as Asset , but for the long run employees its is treated as assets and in short run it is treated as expense in some organisations which having employee of4 to10 and new company , suppose a company hire a employee he work for6 months , but he cant given profit so it is a invesment cum expense , which can't be retreived, so it is one type of expence also.
Prepaid expenses are those expenses which have been paid in advance. In other words, these are the expenses which have been paid during the accounting period for which the final accounts are being prepared but they relate to the next period.
Treatment of prepaid expenses in final account:
If prepaid expenses are given in the trial balance they are recorded in the assets side of Balance sheet only. But if they are given in the adjustments they are subtracted from concerned expenses in the debit side of profit and loss account and again are shown in the assets side of Balance Sheet.
Prepaid expenses refer to those which are paid in advance by a firm before its actual occurance. Hence, only the portion of actual expenses is recorded in debit side of P&L account and the balance of prepaid expenses are recorded on the assets side as current assets.
prepaid expense is the expense is paid in advance
it is treated as asset
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