Prepaid Expenses: Definition, Journal Entry, and Examples (2024)

What are Prepaid Expenses?

Prepaid expenses are payments made in advance for products or services to be used in the future. Prepaid expenses are recognized as an asset because they provide future economic benefits to a company.

While prepaid expenses are initially recorded as an asset, they eventually transition to an expense on the income statement when the product or service is incurred.

Prepaid Expense Journal Entry

Suppose Company A paid 6 months upfront for office rent worth $12,000. The journal entry in month 1 for this would be prepaid rent increasing by $12,000 as a debit, and cash decreasing by $12,000 as a credit.

Prepaid Expenses: Definition, Journal Entry, and Examples (1)

After the 6 months, the company runs out of prepaid rent, and therefore incurs a rent expense of $12,000 and cancels out the prepaid rent of $12,000.

Prepaid Expenses: Definition, Journal Entry, and Examples (2)

Effect of Prepaid Expenses on Financial Statements

The initial entry to record a prepaid expense only affects the balance sheet. Prepaid rent will increase, while cash will decrease. Therefore, there will be no changes in the totals for current assets or total assets.

The second entry, however, does affect both the income statement and the balance sheet. On the income statement, rent expense is recorded, which increases expenses, and in turn, decreases net income. On the balance sheet, current assets decrease as prepaid rent decreases.

Examples of Prepaid Expenses

Examples of prepaid expenses include:

  • Paying for a subscription for a year upfront because they were offering a large discount.
  • Signing a 12-month lease for office space that requires 6 months of upfront payment.
  • Paying for a 24-month insurance policy for office space with cash upfront.

Is Prepaid Expense an Asset?

Yes, prepaid expense is a line item recorded as an asset on the balance sheet. This is because it represents a future economic benefit to the company. For example, if a company pays for 12 months of rent upfront, it expects to receive the benefits of that in the form of having an office space over the next 12 months.

More specifically, prepaid expense is recorded as a current asset. It can sometimes be bucketed with other current assets like in the example below for PepsiCo’s balance sheet. To learn more about PepsiCo's financial statements, you can click here.

Prepaid Expenses: Definition, Journal Entry, and Examples (3)

Are Prepaid Expenses Debits or Credits

From a company’s point of view, an increase in prepaid expenses is a debit. The corresponding cash decrease is a credit. Later, when the prepaid expense is used, a company records an expense for the product or service which is a debit, and the prepaid expense gets canceled out through a credit.

Prepaid Expenses: Definition, Journal Entry, and Examples (4)

Key Summary Recap

  • Definition: Prepaid expenses are payments made in advance for a product or service to be used at a later date.
  • Balance Sheet location: Prepaid expenses are listed as an asset in the balance sheet. More specifically, they are listed under current assets.
  • Prepaid Expenses Debit or Credit?: An increase in prepaid expenses is a debit, while a decrease in prepaid expenses is a credit.

Additional Resources

Want to level up your accounting? Consider checking out our Financial Accounting Essentials where we teach students how to build a balance sheet, income statement, and cash flow statement from scratch based on a set of transactions. You'll also learn to find, read, and analyze the financial statements of real companies such as Microsoft and PepsiCo. Students who have taken this course have gone on to work at Barclays, Bloomberg, Goldman Sachs, EY, and many other prestigious companies. Get started now!

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Prepaid Expenses: Definition, Journal Entry, and Examples (5)

Prepaid Expenses: Definition, Journal Entry, and Examples (6)

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Prepaid Expenses: Definition, Journal Entry, and Examples (2024)

FAQs

What is an example of a prepaid expense journal entry? ›

Prepaid Expense Journal Entry

Suppose Company A paid 6 months upfront for office rent worth $12,000. The journal entry in month 1 for this would be prepaid rent increasing by $12,000 as a debit, and cash decreasing by $12,000 as a credit.

What are prepaid expenses with an example? ›

A prepaid expense is an expense that is paid for in advance. Recurring expenses such as insurance and rent can be paid for with one payment that covers the cost of the expense for several months or even a year. Often, businesses prepay expenses in this manner because they can receive a discount.

What is the correct entry for prepaid expenses? ›

To recognize prepaid expenses that become actual expenses, use adjusting entries. As you use the prepaid item, decrease your Prepaid Expense account and increase your actual Expense account. To do this, debit your Expense account and credit your Prepaid Expense account. This creates a prepaid expense adjusting entry.

Which of the following are examples of prepaid expenses? ›

Common examples of prepaid expenses include leases, rent, legal retainers, advertising costs, estimated taxes, insurance, salaries, and leased office equipment.

What is the journal entry for expenses? ›

How Do You Record a Journal Entry for an Expense? To record an expense, you enter the cost as a debit to the relevant expense account (such as utility expense or advertising expense) and a credit to accounts payable or cash, depending on whether you've paid for the expense at the time you recorded it.

What do prepaid expenses record? ›

Prepaid expenses are incurred for assets that will be received at a later time. Prepaid expenses are first recorded in the prepaid asset account on the balance sheet. The GAAP matching principle prevents expenses from being recorded on the income statement before they incur.

How do you enter prepaid expenses? ›

The following are the steps you can take to record a prepaid expense:
  1. Make the payment for the prepaid expense. ...
  2. Enter it into an accounting journal. ...
  3. Debit the asset account. ...
  4. Expense a portion on the income statement. ...
  5. Repeat the process.
Feb 3, 2023

What is the journal entry for advance payments? ›

Whenever an advance payment is made, the accounting entry is expressed as a debit to the asset Cash for the amount received. A credit also needs to be made to the liability account – something along the lines of Advance Payments, Unearned Revenue, or Customer Advances.

What is prepaid income journal entry? ›

In accounting, when a company receives a prepaid income, it records a debit (increase) to the Cash account and a credit (increase) to a liability account such as Unearned Revenue or Deferred Income. This reflects the company's obligation to deliver goods or services in the future.

What is the most common prepaid expense? ›

The two most common uses of prepaid expenses are rent and insurance.

What is an example of a prepaid expense schedule? ›

What Is an Example of Prepaid Expense Amortization? As an example, if a business prepaid its insurance one year in advance at a cost of $12,000, the expense would be amortized at $1,000 per month. This would be calculated as $12,000 / 12 months = $1,000/month.

Can you record a prepaid without paying? ›

In cash accounting, you only record an expense when money changes hands. A prepaid expense will show up on your balance sheet as an asset, and as the asset is used, it will appear on your income statement as an expense.

How do I post a prepaid expense? ›

The following are the steps you can take to record a prepaid expense:
  1. Make the payment for the prepaid expense. ...
  2. Enter it into an accounting journal. ...
  3. Debit the asset account. ...
  4. Expense a portion on the income statement. ...
  5. Repeat the process.
Feb 3, 2023

What is the journal entry of prepaid income? ›

Prepaid Income Journal Entry:

Debit the Cash or Bank account for the amount received and credit the Unearned Revenue or Prepaid Income account. As goods or services are provided, portions are transferred to the Revenue or Income account.

What is an example of a prepayment? ›

Some examples of prepayment include: Purchasing goods or services as prepaid assets: you might purchase office supplies in bulk, for instance, and pay for them upfront. Repaying the interest on a business loan: you might take out a loan, and make an upfront payment to cover the first few months' worth of interest.

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