Examples of prepaid expenses include rent, insurance premiums, and subscription fees. For instance, if a business pays $12,000 in rent for a 12-month lease on January 1st, the monthly prepaid rent expense would be $1,000. Every company pays insurance premiums either monthly, quarterly, or annually. So when a company has paid the insurance premium in advance for the next period, that extra payment is recorded as prepaid insurance on the Asset side of the Balance sheet. So every company treats it as an asset, and when the period comes, the appropriate amount is shown as an expense under the Insurance expense. Prepaid expenses are basically future expenses which have been paid in advance, with common examples being insurance or rent.
The $50,000 balance in prepaid expense appears on the balance sheet for the month, while the $10,000 rent expense appears on the income statement. As part of the rental agreement, the landlord requests the business prepay six months’ rent before occupying the property. Upon the initial payment, the journal entry recorded by the business debits $60,000 to prepaid expenses and credits $60,000 to cash. Both of these accounts are asset accounts, and the entire transaction affects the balance sheet only.
Why Are Prepaid Expenses Classified as a Type of Asset?
Instead, they are recorded as an asset on the balance sheet until the expenses are incurred. As the expenses are incurred the asset is decreased and the expense is recorded on the income statement. The balance sheet is an “equal sign” with company assets on one side, liabilities plus owners’ equity on the other.
Get a Leg Up on Prepaids
If you accidentally code an extra fee to prepaid expense, the worst case scenario is that you expense the unamortized balance in the prepaid account at the end of the policy. The initial journal entry for a prepaid expense does not affect a company’s financial statements. The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash. Having a legal retainer is usually a necessity before a law firm, or an attorney can kickstart the representation. Thus, when a firm pays for a legal service retainer, the expense will be acknowledged as a prepaid expense on the balance sheet since the company has yet to benefit from the law firm’s services.
As the benefits of the prepaid expenses are availed over time, they are recorded in the income statement. Prepaid expenses are recorded within the prepaid asset account of the balance sheet because it signifies a benefit that can be availed in the future. These expenses are considered assets because it provides prepaid insurance journal entry adjustments economic value to the business in the future. It is recorded in the prepaid asset section of the balance sheet. This is because the company has paid an expense in advance, which will help to ease the expense later. As the expense is paid beforehand, it is treated as a prepaid expense and recorded accordingly.
How to Calculate Interest Receivable & Interest Revenue for Notes Receivable
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We’re dedicated to delivering the most value in the shortest amount of time, equipping you to not only control close chaos, but also foster F&A excellence. Transform your order-to-cash cycle and speed up your cash application process by instantly matching and accurately applying customer payments to customer invoices in your ERP. These are the company’s cash in bank accounts, received but undeposited checks, savings and money market accounts, and liquid investments such as Treasury bills. Companies prepay many other types of expenses, including taxes, utility bills, rents, insurance, and interest expense. Each month, adjust the accounts by the amount of the policy you use.
Refund Life Income Option
The landlord requires that Company A pays the annual amount ($120,000) upfront at the beginning of the year. Alicia Tuovila is an accounting and finance writer based in Tennessee. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts. BlackLine partners with top global Business Process Outsourcers and equips them with solutions to better serve their clients and achieve market-leading automation, efficiencies, and risk control.