Prepaid expenses defer the recognition of expenses. Prepaid expenses are expenses that are paid for in advance by an entity. Because the future benefits that a company will receive from this type of transaction have not yet materialized, these advanced payments are recorded as assets. To record a prepaid expense, debit an asset account for the amount paid and credit cash.
Example:
The benefits of prepaid expenses are received upon use or through the passing of time. As a result of this, companies record an expense only at the end of the corresponding (current) accounting period in which the prepaid expense was consumed. An adjusting entry is made at this time to recognize the expense. This entry will update the account balances, an essential step in the preparation of a company's financial statements. To record the adjusting entry, debit the related expense account and credit the prepaid asset account. Before this entry is made, assets are overstated, and expenses are understated.
Example:
Common Prepayments:
- Insurance
- Supplies
- Rent
- Fixed Assets
- Buildings
- Equipment