Question

What is the difference between an advance purchase and prepaid expenses? Give an Example!

Answer 1

Advance Purchase: It is payment of amount in advance for purchase to be made later. Advance is payment made without actual receipt of goods and services.

Example: A Ltd. paid $10,000 in advance to B Ltd for a purchase of goods, delivery of which is to made after 3 months.   

Prepaid Expense: It is a payment for expense in an accounting period, the benefit for which will accrue in the subsequent accounting period(s).

Example: Insurance is generally paid annually. Suppose insurance was purchased for assets on 01/10/2019 and the annual premium incurred was $12,000. But we know that accounting period is from 1 Jan to 31 Dec. Therefore, expense of $3,000 should be recorded in the current year (at year end) (12,000*3/12). The balance $9,000 is a prepaid expense on the reporting date (Asset) as the expense is already incurred but the benefit for it is to be accrued in the subsequent accounting period.

I hope I've explained to the point. Please feel free to ask any queries and do give a thumbsup if the solution was satisfactory. Thank you.