What Is a Prepaid Expense?
A prepaid expense is an expense that has been paid for prematurely then again now not however incurred. In business, a prepaid expense is recorded as an asset on the stability sheet that results from a business making difficult expenses for pieces or products and services and merchandise to be gained in the future.
Prepaid expenses are to start with recorded as belongings, then again their worth is expensed through the years onto the income remark. No longer like standard expenses, the business will download something of worth from the prepaid expense over the method quite a lot of accounting classes.
Understanding Prepaid Expenses
Companies make prepayments for pieces or products and services and merchandise akin to leased place of business equipment or insurance policy that provide power benefits through the years. Pieces or products and services and merchandise of this nature cannot be expensed straight away given that expense would now not line up with the benefit incurred through the years from using the asset.
In keeping with usually licensed accounting regulations (GAAP), expenses must be recorded within the an identical accounting duration as the benefit generated from the an identical asset. As an example, if a large copying device is leased by the use of a company for a duration of three hundred and sixty five days, the company benefits from its use over the entire period of time. Recording an advanced charge made for the hire as an expense inside the first month would now not adequately are compatible expenses with revenues generated from its use. Due to this fact, it’s going to need to be recorded as a prepaid expense and allocated out to expense over the entire 300 and sixty 5 days.
Mag entries that recognize expenses related to in the past recorded prepaids are known as adjusting entries. They do not record new business transactions then again simply control in the past recorded transactions. Adjusting entries for prepaid expenses are necessary to be sure that expenses are recognized inside the duration in which they are incurred.
As a result of the nature of certain pieces and products and services and merchandise, prepaid expenses will always exist. As an example, insurance plans is a prepaid expense given that serve as of shopping for insurance plans is to buy proactive protection in case something unfortunate happens in the future. Clearly, no insurance plans company would advertise insurance plans that covers an unfortunate match after the truth, so insurance plans expenses must be prepaid by the use of firms.
Example of Prepaid Expense
As an example, assume ABC Company purchases insurance plans for the approaching 12 month duration. It will possibly pay $120,000 prematurely for the insurance policy. ABC Company will to start with book the entire $120,000 as a debit to prepaid insurance plans, an asset on the stability sheet, and a credit score rating to cash. Each month, an adjusting get right of entry to can be made to expense $10,000 (1/12 of the prepaid amount) to the income remark by means of a credit score rating to prepaid insurance plans and a debit to insurance plans expense. Throughout the 12th month, the overall $10,000 can be utterly expensed and the prepaid account can be 0.
