Prepaid expenses refer to goods or services paid for in advance and with the paying company expecting to be able to use them within twelve months. It is a future expense and can be noted in an income statement only after it has been used or consumed (Ward, 2020). Some prepaid expenses include rent or insurance contracts, which stretch over multiple periods and can be seen as a series of similar costs. This allows the company to use the services, products, or property within the period that has been paid for.
Such an expense is treated as a ‘current asset’ until it is consumed on the balance sheet. Upon its use, the asset should be removed from the balance sheet and reported as retained earnings through the income statement. If the asset is not consumed or used within the twelve months, it can be registered as a long-term or non-current asset. According to the GAAP, expenses should be recorded within the same accounting period during which the earnings are generated concerning the asset, service, or product.
If a piece of equipment or machinery is leased for twelve months, the company’s office will benefit from it for the entire duration. However, recording the initial prepaid amount only in the first month would not match the revenue this tool could generate over the twelve months. Therefore, the company is likely to record it as a prepaid expense and allocate it to the expenses of the entire twelve-month period. The main difference between prepaid and accrued expenses is treating one as a current asset and the other as a present liability.
Work Cited
Ward, Andrea. “Prepaid Expenses.” Financial Edge. 2020.