Account for Prepaid Expenses

by Greg DePersio

1 min read

If you want more consistency in your financial statements, consider using the accrual method of accounting to book prepaid expenses. When you originally book your payment, don’t code the charge to an expense account. Instead, code your transaction to a prepaid balance sheet account. Once you’ve received the good or service, reduce your prepaid balance sheet account with a credit and increase your expense with a debit. You cannot record prepaid expenses if you use the cash basis method of accounting.Say you pay $6,000 on Jan. 1 for your rent for the entire year. If you expense the payment, the entire $6,000 would hit in January. If you put this to a prepaid account in your financial statements, you are able to spread this $6,000 across all 12 months of the year. By posting a journal entry each month that adjusts your prepaid balance, you can recognize $500, or the $6,000 annual cost divided by 12 months, each month so your rent expense is consistent. Your journal entry to reduce your prepaid account would involve a debit to your expense account and a credit to your prepaid account.Entering prepaid expenses requires you to keep good records. You need to know when the prepaid was entered and when it is time to convert it to an expense. You want to keep reminders or notifications that let you know when it is time to adjust a prepaid so you don’t forget to move the balance. Instead of using one prepaid account, you can set up several accounts such as prepaid rent, prepaid insurance, or prepaid taxes. Then, be as specific as you want as you move the charge to an expense account for those same items.Prepaid assets smooth out your financial statements. If you pay for things in advance, record the item on your balance sheet and slowly move your balance to the income statement as you receive the benefit.

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