Question

please give 3-5 examples of a business (companies) that would have a significant amount of prepaid assets and explain

Answer 1

A prepaid asset is an expenditure of money in advance of when the money is due. It is an expense that has already been paid for, but which has not yet been consumed. Once the asset has been consumed, it is charged to expense.

Prepaid assets normally involve relatively small amounts. However, sometimes a company wants to beef up its current assets or suppress current expenses, perhaps to qualify for a loan. This can create the temptation to create large prepaid assets even when not justified. For example, you might “prepay” a vendor for items you won’t order until several months later. Or, you might illegitimately claim a large current maintenance expense as a prepaid asset. To avoid these sorts of problems, set a minimum amount for a prepaid asset -- if you prepay an amount below the minimum level, you would simply expense it in the current month. In addition, set up a system of divided responsibilities between your accounting staff and your auditors to monitor for these kinds of abuses.

Examples

Commercial Lease Rent

If a commercial lease agreement requires the prepayment of the last month’s rent or payment of any months in advance, that expense should be posted to the prepaid rent account. If the monthly rent payment is issued in the last week of the previous month, this expense should also be posted to prepaid rent until the month begins. The amount should be posted as a debit to prepaid rent and a credit to cash. Once the new month starts relieve the prepaid by posting a credit to the prepaid rent account and a debit to the rent expense for the monthly rent amount.

Quarterly Estimated Taxes

The quarterly estimated taxes paid by corporations throughout the year are a prepaid tax because they are an estimated payment made in advance of the actual tax liability. Although businesses recognize the expenses associated with a tax liability throughout the year using payable accounts such as payroll tax payables, the actual quarterly estimated payment is recorded as a prepaid expense until the end of the year’s final tax payment is issued.

Debit the prepaid tax account for the amount of the payment, and then credit cash to recognize the reduction in the cash account. Credit prepaid taxes and debit the tax expense account when the actual liability amount is calculated at the end of the year.

Retainer for Legal Expenses

Paying a retainer fee to an attorney is an advance payment toward legal services that the company has a reasonable expectation of incurring. Most attorneys require that clients pay a retainer upfront upon accepting a case. Debit a prepaid legal account with a credit to the cash account for the amount of the retainer. When the legal services are rendered, expense the retainer with credit to prepaid legal and a debit to the legal expenses account.

The quarterly estimated taxes paid by corporations throughout the year are a prepaid tax because they are an estimated payment made in advance of the actual tax liability. Although businesses recognize the expenses associated with a tax liability throughout the year using payable accounts such as payroll tax payables, the actual quarterly estimated payment is recorded as a prepaid expense until the end of the year’s final tax payment is issued.

Debit the prepaid tax account for the amount of the payment, and then credit cash to recognize the reduction in the cash account. Credit prepaid taxes and debit the tax expense account when the actual liability amount is calculated at the end of the year.

Anything Paid in Advance

Any business contract agreements that require a deposit or payment in advance are prepaid expenses. Debit the related prepaid account for the amount of the advanced payment, and credit the cash account for an equal amount. When the services are rendered or the expense is incurred, credit the prepaid account and then debit the corresponding expense account in the ledger.