Why it matters
A prepaid expense keeps a large payment from hitting one month's profit and leaving the next months with no cost. It also keeps the balance sheet honest about what the business has already paid for.
Example
A client pays $12,000 in January for a year of insurance. The bookkeeper records the payment as prepaid insurance, then expenses $1,000 each month so the profit and loss statement shows the cost over the coverage period.
Related terms
Questions about Prepaid expense
Is prepaid rent an asset or an expense?
Rent paid for a future period is an asset until the period is used. The portion that covers the current month is an expense.
How do I know which prepaid expenses to record?
Look for payments that cover more than one period, such as annual insurance, software subscriptions, rent and prepaid interest. A payment for a service already used is an expense, not a prepaid asset.