A prepaid expense is one form of expense that businesses frequently incur, and it occurs when a firm pays in advance for a service or goods. Understanding how to record these charges will help you keep your accounting records up to date.
What are Prepaid Expenses
A prepaid expense occurs when a corporation pays for products or services that have not yet been utilized or received. This sort of expense is often documented on a company’s balance sheet as an asset that is expensed overtime on the income statement. Prepaid goods and services will often give value over a lengthy period of time.
Prepaid Expenses Example
Insurance is a great example of a prepaid expense because it is often paid for in advance. If a corporation pays $12,000 for a 12-month insurance policy, it would record a $12,000 current asset at the moment of payment to indicate this prepaid amount.
Each month of the 12-month policy, the corporation would record an expense of $1,000 and deduct the same amount from the prepaid asset.
Are Prepaid Expenses An Asset
A prepaid expense is a type of asset. When you first record a prepaid expense, make it an asset. So, where do prepaid expenses go? Prepaid costs are represented as assets on the balance sheet.
Prepaid expenses become expenses only when they are used. As you utilize the item, the asset’s value decreases. The asset’s value is subsequently substituted with an actual expense on the income statement.
The basic line is that a prepaid expense item is an asset before you utilize it. When an item is utilized, it becomes an expense.
Prepaid Expenses On Balance Sheet
A prepaid expense is recorded in the balance sheet’s current assets column until the prepaid item is consumed. Once consumed, the prepaid charge is withdrawn from the balance sheet and recorded as an expense on the income statement for that period.
If the entire ending amount in the prepaid costs accounts is quite small, it may be aggregated with other assets and presented on the balance sheet as an “other assets” line item.
Prepaid Expenses Journal Entry
Debit your Prepaid Expense account to make your first prepaid expense journal entry. Why? So the answer is that This account is an asset account, and debits increase assets. And for every debit, there must be an equal and opposite credit.
Credit the account you used to make the payment, such as a Cash or bank account. Crediting the account reduces the amount in your Cash or Bank account.
For Example: On December 30th, 2019, ABC Company pays 1,20,000 (10,000 x 12 months) in cash as rent for the next year, i.e. for the period Jan 2020 to Dec 2020.
When you incur the prepaid expense, write the following journal entry:
|xx/xx/xxxx||Prepaid Rent Expense||1,20,000|
|Cash or Bank||1,20,000|
All 12 months from Jan’20 to Dec’20 will be charged against the prepaid expense account in each period,
Make a debit for $10,000 to record the rent expense. With a credit, you can reduce the Prepaid Expense account. Repeat the procedure every month till the asset account is emptied.
|Prepaid Rent Expense||$10,000|
Are Prepaid Expenses Debits or Credits
When a payment is made that reflects an expense prepayment, a prepaid account, such as Prepaid Insurance, is debited and the cash account is credited. The prepayment is recorded as an asset on the company’s balance sheet.
A consumption plan for the prepaid asset or an amortization schedule that corresponds to the actual incurring of the prepaid expenses is also developed.
According to the schedule, at the conclusion of each accounting period, a journal entry is recorded for the expense incurred during that period. This journal entry credits a balance-sheet prepaid asset account, such as Prepaid Insurance, and debits such as Insurance Expense.
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