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What are Prepaid Expenses?

Prepaid Expenses

Prepaid expenses are those expenses which have been paid in advance, however, the related benefits are not received within the same accounting period. The benefits of expenses incurred are carried to the next accounting period. Prepaid expenses are treated as an asset for the business. 

Examples – Prepaid salary, prepaid rent, prepaid subscription, etc. They are recorded in books of finance at the end of an accounting period to show the true numbers of a business. They are also known as unexpired expenses or expenses paid in advance.

Prepaid (unexpired) expense is a personal account and is shown on the assets side of a balance sheet.

Example and Simplification

Company-A has a rent obligation of 10,000/month that is paid on every 10th, this year the company has paid for 13 months i.e. one month is paid in advance.

The amount for 1 month which is prepaid is termed as “prepaid expense” for Company A.

At the end of the period, this “amount paid in advance” impacts the financials of the business. Such a transaction is supposed to be journalized.

Summary of prepaid expense

Prepaid Expenses in a Nutshell

According to the accrual concept of accounting, transactions are recorded in the books of accounts at the time of their occurrence and not when the actual cash or a cash equivalent is received or paid. 

Based on the above principle payments are not necessarily made immediately they may be late or in advance. Outstanding expenses and unexpired expenses are both a result of this.

 

Journal Entry for Prepaid Expenses

It involves two accounts: Prepaid Expense Account and the related Expense Account

Prepaid Expense A/C Debit Debit the increase in asset
 To Expense A/C Credit Credit the decrease in expense

(Expense paid in advance recorded as an entry)

Related Topic – Treatment of Prepaid Expenses in Financial Statements

Prepaid Expenses in Trial Balance

If such an expense already appears inside the trial balance then it implies that the adjusting entry has already been posted.

In this case, it is only shown in the balance sheet as a “current asset” and no adjustment is required in the income statement.

 

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