Accruals & Timing
Prepaid Expense
A cost you've paid before using the benefit — recorded as an asset, then expensed gradually as it's consumed.
A prepaid expense is cash out the door ahead of the expense itself: annual insurance, a year of software billed upfront, a deposit on office space. Because the benefit spans future periods, you record the payment as an asset (prepaid), then amortize it into expense month by month as the benefit is used up. Each month's adjusting entry debits expense and credits the prepaid asset until it reaches zero.
The mistake happens in both directions. Expensing the full $12,000 in January makes January's P&L brutal and the next eleven months look artificially cheap — distorting every month-over-month comparison. Forgetting to amortize at all leaves the asset on the balance sheet forever and expenses understated. The correct treatment is boring by design: spread the cost across exactly the periods the payment covers.
Example
You pay $18,000 on July 1 for twelve months of software. July 1: prepaid expense asset $18,000, cash down $18,000, expense $0. Each month: expense $1,500, prepaid asset down $1,500. By next June 30 the asset is fully expensed and the P&L shows $1,500 a month.
Common questions
What is the difference between a prepaid expense and an accrued expense?
Prepaid means you paid before you incurred the cost — it starts as an asset. Accrued means you incurred before you paid — it starts as a liability. Prepaids are deferred costs; accruals are unrecorded costs.
Is rent always a prepaid expense?
When you pay rent before the month it covers (the common case), yes. The cash leaves first, and the expense belongs to the period the space was actually used. It's one of the most frequent adjusting entries in any close.
Practice this in the game
Accrual World turns concepts like these into playable drills. Pick the account, pick debit or credit, and get instant feedback. Free, no signup.
Play now