Accounting for Prepaid Expense
We will learn when a business records expense as incurred and when expense is considered paid in advance. We will also learn how to record expense in the journal, including adjustments for prepaid expense, and how to interpret an expense account.
Related Lessons:
Determining Prepaid Expense
Expense is regarded as incurred when the benefit has been used, regardless of whether payment is made.
Expense is regarded as paid in advance when payment is made before receiving the intended services. Therefore, prepaid expense is a current asset to the business.
To calculate prepaid expense:
- Calculate total expense incurred for the accounting period.
- Determine the total amount paid for the accounting period.
- Amount paid in excess of total expense incurred is regarded as prepaid expense.
Adjusting for Prepaid Expense Brought Forward
Expense paid in the previous accounting period is carried forward to the next accounting period when the business receives the service owed to it. At this point, the amount is no longer treated as a current asset and is recognised as expense incurred.
Therefore, the amount is transferred from the current asset account to the expense account to record the expense for the current year, as the benefit has now been used..
Dr Expense
Cr Prepaid expense
Recording Prepaid Expense
1. To record prepaid expense brought forward
Dr Expense
Cr Prepaid expense
2. To record expense paid
Dr Expense
Cr Cash at bank
3. To record prepaid expense for the current period
Dr Prepaid expense
Cr Expense
4. To close the expense account
Dr Income summary
Cr Expense
Interpreting Expense Account
The following transactions in the expense account are interpreted as such:
Prepaid expense on the first day of the accounting period
Refers to expense paid in the previous accounting period, for services to be utilised in the current period.
Cash at bank
Refers to expense paid via the bank account
Prepaid expense on the last day of the accounting period
Refers to expense paid now for services to be utilised only in the next accounting period
Income summary
Refers to total expense incurred in the current accounting period
Prepaid Expense in the Financial Statements
Amount transferred from the expense account to the Income Summary account is recorded in the Statement of financial performance as an Expense.
The amount of prepaid expense at the end of the current accounting period is recorded in the Statement of financial position as a Current Asset.