Timing

Prepaid expense

Money paid now for a benefit the business will receive later, such as future insurance coverage.

01

Technical definition

A payment made before the related good or service is consumed, initially recognized as an asset.

02

How it works

The prepayment represents a future benefit. As time passes or service is received, an adjusting entry reduces the asset and recognizes expense.

03

Everyday example

A twelve-month $12,000 insurance policy paid on 1 October leaves $9,000 prepaid and $3,000 expense at year-end.

04

Common pitfall

The full cash payment does not become expense immediately when benefit extends beyond the current period.