There are often times when you need to pay to your suppliers in advance. The reasons for why you’d need to do this may be what they are, but what matters to you, is recognizing those prepayments properly on your financial statements and treating them properly in your accounting. Continue reading
Instead of spreading expenses over period they relate to one could simply add the total to one period’s expense and be done with it. Of course, that is an option.
However, when you think about it, wouldn’t it make more sense to have an expense spread? Surely you can see the benefits – less expense for one period for one. Continue reading
Why would someone pay amounts up front? Surely voluntary you wouldn’t give away money before the date of payment has really arrived. Or is it so? Truth of the matter is that prepaying is a normal course of business for some types of expenses and done more often enough. Continue reading
Prepaid expenses are sums paid to suppliers that on your own balance sheet accumulate under one or a few balances all containing the word “prepayment” or “prepaid”. It’s to refer that those amounts are to be your future expenses and at this point they’re just amounts of money you’ve already paid to your suppliers. They’re your assets just in different form than money. Continue reading
On the balance sheet under current assets there may be prepaid expenses accounts, which in essence are future expenses the company has made an advance payment for. We have previously discussed those prepayments and how to initially treat them on the balance sheet (including relating accounting entries), however what we have come across during our practice, are the different treatments in terms of recognizing the expense in proper period.
Essentially, in accruals based accounting all the expenses must be recognized in the period they relate to and not when either the payment is done or when the invoice is received. When using the accruals based accounting methods, you have to make sure the expense you recognize in current period, also relates to this period (usually determinable by the essence of the expense, i.e. rental payments or advertizing on local newspaper during a specified period etc).
As it happens, in normal course of business you may be paid in advance for something that you still have to do. You will be given resources to use and as such, you have taken a liability on your balance sheet. You are given money in return for a promise to provide a service or sell something in near future. As such the company has a legal liability and this is recognized as one.
When the prepayment is received the entry in the accounting is this:
Dr Cash or cash equivalent
Cr Prepayment received
With this you increase the liability for future actions that you have to do (i.e. revenue still to be earned) and on the other side you gain an asset (resources received).
There are times when you are either asked to make a prepayment for certain services or goods, or you simply decide to make an advance payment regardless of the reason behind it. When you make a prepayment, you give away money against a promise to receive something in near future. As such the payment done is accounted for as an asset on the balance sheet. The company has a legal right to receive the service for an example, thus it’s recognized as an asset for the company.
When first making the prepayment, the accounting entry is as follows:
Dr Prepaid expense account
Cr Cash or cash equivalent
With credit you give away money and with debit you gain an asset instead.