![]() ![]() ![]() Small businesses often rent equipment for business use, and you would treat a prepaid expense for equipment rental the same as you would a prepaid property lease or prepaid insurance. Equipment could be a prepaid expense if you paid for it in advance. One of the most common questions that small business owners ask concerning prepaid expenses is whether equipment is considered a prepaid expense. ![]() It’s imperative to record prepaid expenses correctly because if you don’t, your bookkeeping records will not be indicative of the actual financial state of your company. These are only a few examples of prepaid expenses- there are many more situations that call for you to use prepaid expense accounting. If you pay $15,000 upfront for your lease that lasts three months, you would record this transaction using prepaid expense accounting and create journal entries that show how $5,000 is expensed for each of the next three months. The prepaid expense principle should also be applied to a lease on the business property you pay for in advance. You would treat this transaction as a prepaid expense and create journal entries that show how $1,000 is expensed for each of the next 12 months. Imagine a scenario where you pay $12,000 upfront for an insurance policy that lasts 12 months. The same principle can be applied to an insurance policy that you pay for in advance. Then over the next two months, $2,500 of the rent is expensed (used up). If you pay $5000 in June for the months of July and August, the rent amount is initially recorded as a prepaid expense as soon as it is paid. Paying for rent in advance is a very cut and dry example of a prepaid expense. If you are still not quite sure about what constitutes a prepaid expense, that’s okay! In the following list, we will go over some examples of prepaid expenses: This provides more accurate financial statements and provides a better comparison to expenses period to period. The main purpose of recording prepaid expenses is it matches the expense to the period in which it is delivered. You can record them as expenses if that is your preference, but this is not the preferred way to deal with prepaid expenses nor does it comply with generally accepted accounting principles under the accrual method of account. So, prepaid expenses will be recorded as assets on the balance sheet instead of liabilities. ![]() Prepaid expenses are recorded as assets because these expenses will allow the business to secure some sort of benefit in the future. It may seem odd that prepaid expenses are treated this way, but there is a clear reason. We will go over how to record a prepaid expense later on in this article. Whenever you pay for something before you receive it, you should create a journal entry for the prepaid expense for tracking purposes. But what’s not so obvious is the fact that prepaid expenses are limited to the money paid for services that will be used by the company within 12 months. The company pays an expense in advance for certain services or products to be delivered in the future. Prepaid expenses are exactly what they sound like, expenses that have been prepaid. In this section, we will define prepaid expenses in plain English. So, having a solid understanding of prepaid expenses is important. Keeping clean financial books is crucial to the financial health of any company, let alone a small business. An In-depth Definition of Prepaid Expenses ![]()
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