What are prepaid expenses?
When you pay for something before you use it, you've bought a future benefit. Under the [accrual basis](/glossary/accrual-basis) and the [matching principle](/glossary/matching-principle), that payment is an asset at first and becomes an expense over time.
Common examples
- Annual insurance premiums
- Rent paid in advance
- Annual software or SaaS subscriptions
- Prepaid advertising
- Retainers and maintenance contracts
Accounting entries
- On payment: debit prepaid expenses, credit bank.
- Each month: debit the expense account, credit prepaid expenses.
Example
A business pays $6,000 on 1 January for 12 months of insurance. It records a $6,000 prepaid asset. Each month, $500 moves to insurance expense. On 31 March the prepaid balance is $4,500.
Prepaid expenses vs accrued expenses
- Prepaid: paid before use (an asset).
- [Accrued expenses](/glossary/accrued-expenses): used before paid (a liability).
Why it matters
Without prepaid accounting, the month you pay looks very expensive and later months look unrealistically cheap. Spreading the cost gives accurate monthly profit.