prepayments

Prepayments, or prepaid expenses, are payments made for goods or services before the related benefit is received. In accrual accounting, prepayments are classified as assets on the balance sheet rather than expenses until the service or product is consumed. They recognize that the economic benefit occurs in a future period rather than at the time of payment.

When a prepayment is made, the entry is typically a debit to a prepaid asset and a credit to cash or accounts payable. As the service is used or the time passes, the balance is transferred to the appropriate expense: a debit to the relevant expense and a credit to the prepaid asset. This process matches the cost to the period in which the benefit is received.

Common examples include prepaid insurance, prepaid rent, subscriptions, and maintenance contracts. Depending on the timing and duration of the benefit, prepayments may be classified as current assets (benefits expected within one year) or noncurrent assets (benefits extending beyond one year). If the service is not delivered, or if the arrangement is cancelled, the prepayment may be impaired or written off.

Prepayments affect both the balance sheet and the income statement by deferring expense recognition until the service is consumed. In some cases, a prepaid asset may be amortized over the period benefited, using a straight-line or similar method.

Prepayments are distinct from deposits or advances. A deposit is typically a security or refundable payment and may be recorded as a liability by the recipient. When customers prepay for goods or services, the seller often records it as deferred revenue (a liability) until performance occurs.