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).

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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).

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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.

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