Prepaid Expenses
Payments made in advance for goods or services to be received in a future period, recorded as current assets on the balance sheet.
What is Prepaid Expenses?
Prepaid expenses are costs a company has paid in advance for goods or services that will be consumed or received in a future accounting period. Because the economic benefit has not yet been received, prepaid expenses are initially recorded as current assets on the balance sheet, not as expenses. As the benefit is consumed over time, the prepaid amount is gradually transferred to the appropriate expense account on the income statement. Common examples include prepaid insurance, prepaid rent, prepaid subscriptions, and prepaid maintenance contracts. Prepaid expenses are a practical application of the matching principle, ensuring that costs are recognized in the period they provide benefit.
Example
A company pays $120,000 on January 1 for a one-year property insurance policy covering the full calendar year. At the time of payment, it records a $120,000 prepaid insurance asset. Each month, it recognizes $10,000 in insurance expense and reduces the prepaid balance by the same amount. By December 31, the prepaid expense has been fully expensed and the asset balance returns to zero. This treatment ensures the $120,000 cost is spread across the 12 months it protects, rather than being charged entirely to January.
Source: Investopedia — Prepaid Expenses