Prepaid expenses – how to account them

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.

Those prepayments are just cash outflows and not expensed when initially recognized. When the period arrives for which this expense relates to however, the following expense entry is made:

Dr Expense account

Cr Prepaid expense account

With this entry’s debit side you increase expenses and with credit side you decrease the asset side. Since you received services or goods, keeping them as assets is no longer right. In fact they need to be expensed because the usage of them relates to this period.

Things get more interesting when those expenses relate to a longer period. What is done then, is the same entry as above, only the amount is not full, but portion of the prepaid amount. Let’s say that you have prepaid 100 EUR for a 10 month period. The first entry is as follows:

Dr Prepaid expense account 100

Cr Cash 100

Now the next entries are all similar and made for the next 10 month:

Dr Expense account 10

Cr Prepaid expense account 10

We strongly suggest having a list of all your prepaid expense items as well their periods in one compact table. With more than a few items this may get confusing as well as some items are bound to be forgotten (especially since there aren’t any invoices etc coming in to remind you of them).