Accounting for prepayments – the best treatment method

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).

When you have determined the period or periods this expense relates to, you can move forward with your accounting entries. Now this is something where there are different practices. Whereas most common practice is to make the entries in every month and not make a fuss about making bulk entries or anything of the sort, there are cases, when different means may be more effective.

There are those who do the entries for a whole quarter at once, which is really dependable on the essence of the payment. If it is an annual payment meaning it is done for the whole year, it may the effective method to spread expenses over the year.

Then there are those accountants, who prefer to make all the entries related to the expense in one go to all future periods this expense relates to. Again, in case of numerous prepaid expenses this may help to decrease the misstatement rate or the risk that some period charge may be forgotten completely.

Whatever you decide is the best, make sure you have an Excel or similar spreadsheet for all those prepayments done, the periods they relate to and also expenses charged in every portion of the period (i.e. month or quarter).