Question

What are prepaid expenses? Give four examples.​

Answer 1

Meaning

• A Prepaid expense represents an amount that we have paid for the benefit (Goods or services) to be received in future.

• These benefits could be in the form of anything like goods or a services.

• A pre-paid expense is classified as an asset under accrual basis of accounting as we are paying for the future benefits that we are going to receive or consume. In other words, prepaid expenses will be shown in balance sheet as an asset.

• And when we actually received or consumed the future benefits we are taking about, we will expense the prepaid expenses. Means, prepaid expense would turns into an expense to the extent we actually received or consumed the benefit and will be shown in Income statement as an expense.

Examples

1. Prepaid Rent expense

Let's say, a commercial space like a building is taken by you, a self-employed person, on rent from its owners for a rent amount of $1,000 each month to carry on your business operations.

And you have paid the rent of $6,000 for the coming 6 months for the above commercial space.

You literally paid an amount of $6,000 for the months you don't enjoy the benefit or occupied yet.

Since you paid an amount of $6,000 for the future months, this cash outflow will be considered as a prepaid expense and will be shown as an asset under your balance sheet.

This amount you paid in advance will turn into expense once you occupied the commercial space during the months for which you have paid in advance.

Other examples for prepaid expenses are listed below:

2. Prepaid salaries (Advance salaries) paid to employees

3. Prepaid Insurance expense

4. Prepaid interest expense

5. Paid in advance to your lawyer or any other professional for the services to be received in future

6. Paid in advance to your suppliers for the goods they will sent in future.