Definition of Prepaid Expense
A prepaid expense refers to an amount that a company has paid and a portion or all of it will be an expense in a later accounting period.
Example of a Prepaid Expense
A company with an accounting year ending on December 31 has a prepaid expense if on December 1, it paid $6,000 for insurance coverage from December 1 through May 31.
Recording a Prepaid Expense
A prepaid expense can be recorded initially as an expense or as a current asset. Either way, adjusting entries will be needed during the six months to be certain that:
- The current month's insurance expense of $1,000 ($6,000/6 months) is reported on each month's income statement.
- The unexpired amount of the prepaid insurance is reported on the balance sheet as of the last day of each month. For example, on December 31 the balance sheet must report $5,000. On January 31 the balance sheet must report $4,000, and so on.