Prepaid Expenses: How to Account for Them, With Examples

You paid for a year of insurance in January. If you record the whole payment as January’s expense, January looks terrible and the other 11 months look better than they are.

Prepaid expense accounting fixes that. Here’s how it works, with journal entries and a schedule you can follow.

What Are Prepaid Expenses?

A prepaid expense is a payment for goods or services you’ll receive in a future period. It’s recorded as an asset when you pay, then moved to expense as you use it.

Prepaid expenses follow the matching principle: expenses belong in the period they help generate revenue, not the period you happened to pay.

Common Prepaid Expenses

• Insurance premiums
• Rent paid in advance
• Annual software subscriptions and licenses
• Maintenance and service contracts
• Advertising paid before it runs
• Retainers paid to attorneys or consultants
• Property taxes paid in advance

One that’s often confused: security deposits aren’t prepaid expenses. You expect to get a deposit back, so it’s recorded as a separate asset and never becomes an expense.

How to Record a Prepaid Expense

Prepaid expense accounting takes two steps.

Step 1: Record the Payment as an Asset

When you pay, debit the prepaid asset account and credit cash.

Step 2: Move It to Expense Over Time

At the end of each period, usually monthly, debit the expense account and credit the prepaid asset for the portion you used. This is an adjusting entry, and it’s called amortizing the prepaid.

New to debits and credits? Read Journal Entries Explained With Examples.

Prepaid Expense Examples

Example 1: Prepaid Insurance

On January 1, a business pays $6,000 for a 12-month insurance policy.

On January 1:

At the end of each month ($6,000 ÷ 12):

Example 2: Prepaid Rent

On October 1, a business pays three months of rent in advance: $9,000, or $3,000 a month.

On October 1:

At the end of October, November and December:

Example 3: Annual Software Subscription

On July 1, a business pays $2,400 for a one-year software subscription.

On July 1:

At the end of each month ($2,400 ÷ 12):

Prepaid Expense Amortization Schedule

An amortization schedule shows how much expense you recognize each month and what’s left in the prepaid account. Here’s the schedule for the $6,000 insurance policy in Example 1:

Keep one schedule for every prepaid. At month-end, the remaining balances on your schedules should match the prepaid accounts on your balance sheet.

Prepaid Expenses vs. Accrued Expenses

They’re opposites, and both are adjusting entries.

How Prepaid Expenses Affect Your Financial Statements

On the balance sheet, a prepaid expense starts as an asset. Prepaids you’ll use within 12 months are current assets. Any portion that extends beyond 12 months is a noncurrent asset.

On the income statement, the expense appears gradually, one period at a time, as you use the benefit.

Get it wrong, and both statements are off. Expensing a full year at once understates profit in the month you pay and overstates it in the months after. Forgetting to amortize overstates your assets.

Prepaid Expenses Across Different Businesses

Common Challenges and Best Practices

Challenges

• Choosing the right period: the amortization period should match the term of the benefit
• Tracking many schedules: every policy, lease and subscription needs its own
• Missed adjusting entries: when month-end gets busy, amortization is easy to skip

Best Practices

• Keep an amortization schedule for every prepaid
• Reconcile prepaid balances to your schedules every month
• Set a materiality threshold. Many businesses expense small prepaids immediately rather than tracking them.
• Use your accounting software’s recurring journal entries to automate amortization
• Write down your policy, so everyone records prepaids the same way

A note on taxes: tax rules for deducting prepaid expenses can differ from how you record them on your books. Ask your CPA how they apply to your business.

Prepaid Expenses FAQ

Is a prepaid expense an asset?

Yes. A prepaid expense is an asset, because you’ve paid for a future benefit you haven’t used yet. It becomes an expense as you use it.

Where do prepaid expenses go on the balance sheet?

Prepaids used within 12 months are current assets. Any portion beyond 12 months is a noncurrent asset.

What’s the journal entry for a prepaid expense?

When you pay, debit the prepaid asset and credit cash. Each period, debit the expense and credit the prepaid asset for the portion used.

What’s the difference between a prepaid expense and an accrued expense?

A prepaid expense is paid before you use it and recorded as an asset. An accrued expense is used before you pay it and recorded as a liability.

Are security deposits prepaid expenses?

No. Deposits you expect to get back are recorded as a separate asset, not a prepaid expense.

Let a Bookkeeper Handle the Schedules

Prepaid expenses are easy to record and easy to forget. BELAY’s U.S.-based bookkeepers keep your amortization schedules current and your books reconciled every month. Need more? Explore BELAY Financial Solutions, including controller and CFO support.

Related reading: How Much Does a Bookkeeper Cost? | What Is Fractional Accounting? | Bookkeeping 101: Basics for Beginners

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