How many times have you noticed that the prepaid expenses appear in the section of the balance sheet? If always, you are not the only one to discover this. In any financial model, the prepaid expense of a company is generally modeled and tied to its other operating expenses.
There are times when the relationship between the operating expenses and upfront payment is not clear. Then, the prepaid expense amount projection will be linked to the revenue growth. Before diving deep into the technical jargon, we will first tell you what is a prepaid expense all about.
The Definition Of Prepaid Expenses
The future expense of any company that has been paid in advance is known as prepaid expenses. For example, insurance or rent paid will be the prepaid expenses. On the balance sheet, you might find prepaid expenses recorded in the section of the asset. But why is this so?
One might consider prepaid expenses as current assets, and there is nothing wrong with it. So, you just got the answer of prepaid expenses appear in what section of the balance sheet? They appear in the asset section as the business already pays those amounts in advance. Generally, these are in exchange for products and services.
The prepaid expense is particularly related to the buying of a service, like insurance for rent. This might offer value to the company over various accounting periods. As one continues to realize the advantages of products and services, the asset’s value goes down.
How Do You Record Prepaid Expenses?
As mentioned above, the prepaid expenses are first recorded on the balance sheet existing in the prepaid asset account. Once you know how to record, knowing where do prepaid expenses appear will no longer be a big deal. These denote the future benefits of them in the business.
In financial terms, prepaid expenses are regarded as current assets as they are predicted to be used and consumed. The duration of exhausting the prepaid expense limit is one complete year via standard business operations. Owing to their special value, prepaid expenses appear in the section of the balance sheet named assets.
As the advantages of the prepaid expense continue to be realized, its prevalence is seen on the income statement. Initially, they are not logged on the income statement owing to the GAAP or Generally Accepted Accounting Principles. This principle makes it a bit complex to record the income statement prior to their incurring.
Instances Of Prepaid Expenses
Owing to the dependency on how products and services are sold, various brands will have a prepaid expense or two. No insurance company actually tells you prepaid expenses appear where on balance sheet, you just have to find it all by yourself. Here are the three most common instances of a prepaid expense.
A rent, prepaid, is basically a lease payment that has been made for the coming future. It is the most classic example of prepaid expenses. A firm initiates a cash payment to the leading firm. However, the rent expense is not incurred yet, so the firm has to record the prepaid rent.
Prepaid rent is usually an asset as the amount is easily payable in the future. This reduces the rent expense and other concerns related to it when incurred.
Prepaid insurance is the second-most perfect instance of a prepaid expense. On knowing where do prepaid expenses appear on the balance sheet, you might also want to discover where prepaid insurance gets recorded. Insurance is paid in advance always; hence it marks an important consideration.
Take, for instance, a company paying $12,000 for a specific insurance policy that extends for the next 12 months. In this case, it would log a current asset valued at $12,000 at the payment time. This will represent the prepaid expense amount.
In every single month of the entire one-year policy, the firm will recognize a $1000 expense and subsequently debit it from the prepaid asset.
Legal Services Retainer
Right before a firm or a lawyer begins representation, there is the need for a legal retainer. On paying the retainer, the company has to record it as a prepaid asset on its balance sheet. The legal retailer prepaid expenses appear in the section of the balance sheet named assets.
It is not immediately expensed owing to the company not benefitting from its services. When future invoices keep coming in, the firm will recognize it as an expense and later draws it down the prepaid asset account.
Is A Prepaid Expense Considered A Debit Or Credit?
Whenever there is a payment representing an expense’s prepayment, money is debited from the prepaid account. Again an example is Prepaid Insurance which gets debited and the cash account which gets credited. The prepayment as a company’s asset is recorded on the balance sheet of the firm.
Here’s exactly where the prepaid expenses appear in the section of the balance sheet. This denotes that an amortization schedule is needed to correspond to the actual incurring amount of the prepaid expense.
Once the accounting period ends, a journal entry gets posted for the incurred expenses all through the stated period. The journal entry is responsible for crediting the prepaid asset account mentioned on the balance sheet.
Wrapping It Up
To sum up, simply, prepaid expenses refer to the amount paid in advance. It consists of everything, starting from insurance to utility bill payments and even subscriptions. Prepaid expenses provide tax benefits that assist you in hedging against inflation.
With prepaid expenses, you also ensure that nothing is missed when recording every small detail on the balance sheet. We hope this article made it clear why prepaid expenses appear in the section of the balance sheet classified as assets. Don’t forget to comment down below and communicate your ideas to us!