As time goes by and the supplies get used, you have to make adjusting entries on your financial statements to convert these supplies into an expense. To illustrate, let’s assume a construction company purchases $10,000 worth of office supplies in January. They just adjust the accounts so that expenses are recognized at the time they incur. Keep in mind that adjusting entries do not record any new business transactions. Adjusting Entries for Prepaid ExpensesĪdjusting entries are journal entries necessary in order to convert assets into expenses. Want to learn more about the different types of accounts that come in useful for today’s small business? Head over to our guide on the chart of accounts. Here’s how the journal entry should look like: Then, to keep the transaction balanced, you have to credit Cash, since it decreases, for $800. Why? Because prepaid insurance is an asset account, and as we mentioned, assets are increased by debits. To create the journal entry for this transaction, first, you have to debit the Prepaid Insurance account for $800. Let’s assume your business purchases insurance for 8 months for $800. Now, this might seem a bit confusing to grasp, so let’s check out an example. These accounts are increased by debits and decreased by credits. In double-entry bookkeeping, every transaction affects two accounts equally at the same time, where one account is debited and the other is credited.įor prepaid expenses, the two main accounts you’ll need to focus on are assets and expenses. To make a journal entry, you first need to understand the concept of double-entry bookkeeping and debits and credits. We’ll go into more detail about adjusting entries as we go along, but first, let’s check out how to make journal entries for prepaid expenses. This recognition of expenses is done through adjusting entries. In simpler terms, prepaid expenses are assets that turn into expenses as their value drops. That’s why prepaid expenses are first recorded as assets in the balance sheet.Īs the asset value starts to decrease, the prepaid expense is removed from the balance sheet and expensed in the income statement. That’s a fair assumption, but as we mentioned, expenses are not recognized when you pay for them, but when they get used. You may be thinking: a prepaid expense is an expense account, right? It’s in the name! What Type of Account is a Prepaid Expense? These payments in advance can be for equipment, supplies, rent, insurance, and anything else the business pays for before using it. ![]() An accounting period can be a month, a quarter, or a full fiscal year. So, prepaid expenses are payments for purchases that will be consumed throughout two or more accounting periods. On the accrual basis of accounting, expenses get recognized when they are used, consumed, utilized, or have expired, not when they get made. Automate Prepaid Expenses with Accounting SoftwareĪ prepaid expense (also known as prepayment) is a payment made in advance for an expense that hasn’t occurred yet.īut what does it mean for an expense to occur?.Read on for an in-depth look at the following topics: This guide has the information you’re looking for and provides examples suited for small businesses. In the accounting cycle, these advance payments are recorded as prepaid expenses.Īre prepaid expenses an asset or expense account? How do I record a prepaid expense in my accounting books? When managing a business, you have to pay for some assets in advance, such as rent or insurance.
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