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What are the two methods for recording prepaid expenses?

The two methods for recording prepaid expenses have to do with the general ledger account that is initially debited at the time of the cash payment. The two methods or approaches are:

  1. debit an asset account (such as Prepaid Insurance) which is the balance sheet method, or
  2. debit an expense account (such as Insurance Expense) which is the income statement method.

The use of either method will almost always require an adjusting entry prior to issuing the company's financial statements. However, the amount, the account that will be debited, and the account that will be credited in the adjusting entry will depend on the method used.

In short, either the balance sheet method or the income statement method for recording prepaid expenses may be used as long as the asset account balance is equal to the unexpired or unused cost as of the balance sheet date.