You pay for a good or service upfront. You think the cash is gone right away. But in accounting, this isn’t always the case. Something called “prepaid expense” reflects on your balance sheet as an asset.
Here’s the thing: prepaid expenses hold future value. They sit as current assets on your balance sheet until they become real expenses. That’s how accounting logic works.
In this guide, we’ll strip down the logic and show how prepaid expenses move through your books. We’ll also show how automation saves you from headaches during month-end closes.
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Prepaid Expenses: Payments Today, Benefits Tomorrow
A prepaid expense is exactly what it sounds like. It’s money you hand over before you get what you paid for.
Think of paying rent on the first of the month even when it’s not due until the 15th of the next. The same logic applies to locking in an insurance premium for the year.
It also happens with software subscriptions. You might choose to avail an annual subscription over a monthly one. Regardless of the reason, the payment you make in advance qualifies as a prepaid expense.
To put it simply, prepaid expenses are like holding a ticket for a service you’ll “consume” later.
Why Prepaid Expenses Count as Assets
Accounting treats prepaid expenses as assets because the benefit hasn’t been used up yet. You’ve paid, but you still own the right to use the services or resources later. The “unspent” value is what makes them assets.
It’s like buying a ticket for a concert happening three months from now. You’ve already paid for the show, and the ticket serves as its proof.
The ticket holds value because it guarantees you a seat in the show. But it’s not the actual benefit. Rather, it represents the benefit you’ll be getting, which in this case is the concert itself.
Regular expenses don’t work this way. Take the coffee in the breakroom as an example. Once everyone’s had their cup, there’s nothing left to “save” for next month. There’s no future value to defer, which is why it goes straight to the income statement.
This ties back to the matching principle in accounting. The cost becomes an expense only when you actually receive the benefit. Until then, that cash stays on the balance sheet as an asset.
Where Prepaid Expenses Show Up on the Balance Sheet
Prepaid expenses show up on the balance sheet in several ways. Depending on the business and reporting style, you might see them:
- As a separate line item. In most cases, they are clearly labeled “Prepaid Expenses” under Current Assets.
- Grouped under “Other Current Assets.” This is often done when the amounts are smaller or less frequent.
- Broken down by type. They can show up as prepaid rent, prepaid insurance, or prepaid software in the company’s internal records.
Here’s how it might look like:
In this example, we see $25,000 in prepaid expenses. It covers items like office rent, annual insurance, and software licenses.
Note: Lumping everything under “Other Current Assets” keeps things tidy. But it can also make you lose track of how much money is sitting in prepaids. That’s why businesses track details internally, even if the external balance sheet shows only one line.
How Prepaid Expenses Move from Assets to Expenses (Journal Entry Step-by-Step Guide)
Prepaid expenses don’t stay assets forever. As you use them up, they shift from the balance sheet into expenses on the income statement. The accounting entries make that movement clear.
Here’s how it works step by step:
Step 1. When You Pay Upfront
Example: Your company pays $16,500 for one year of office rent.
At this point, you haven’t “used” the office yet. You just paid early. So, you treat the payment as an asset called Prepaid Rent.
Journal entry at payment:
Debit: Prepaid Rent (Asset) .................................... $16,500
Credit: Cash (Asset going down) ................................ $16,500
Step 2. As Time Passes
Each month, you “use up” one month of rent. That’s when the prepayment turns into a real expense. For $16,500 paid upfront, that’s $1,375 per month.
Journal entry each month:
Debit: Rent Expense (Expense) ................................... $1,375
Credit: Prepaid Rent (Asset) .................................... $1,375
Step 3. Adjusting Entries at Month-End
At the end of every month, you need to check how much of the prepayment is left. Then, you record adjusting entries to ensure the following:
- The balance sheet should only show the unused portion of prepaid rent.
- The income statement should only reflect the rent expense for that month.
By the 12th month, the prepaid balance should be $0. And the full $16,500 should have flowed into rent expenses.
Bottom line: Prepaid expenses are about timing. The entries make sure costs show up in the right months. This way, your financial records are clean, accurate, and reliable.
The Role of Prepaid Expenses in Close Prep
Prepaid expenses affect both the balance sheet and the income statement. You must record them in the right period to keep reports accurate. Misstated expenses and overstated assets make financial records unreliable.
Most teams still track prepaids with manual spreadsheets. This leads to problems like:
- Forgetting to spread out costs month by month
- Mixing up the amounts that should be expensed
- Carrying the wrong balances into the next period
Let’s say you pay $24,000 upfront for a 12-month policy. But you mistakenly record the full amount as an expense in January. As such, that month looks like a loss. Meanwhile, the rest of the year looks stronger than it should.
This mistake happens so often that auditors look out for it first in compliance checks. If you want clean reports, you need to focus on accurate prepaid tracking. It keeps your finances audit-ready every time.
Prepaids Made Easy with Balance Sheet Automation
Manual prepaid tracking is a grind. Balance sheet automation takes the pain out of it. It turns prepaid expense tracking into background work.
Once you set it up, amortization schedules run on autopilot. The system creates and updates them as needed.
With this, prepaid expenses move from assets to expenses in the right month. You won’t have to go in and update spreadsheets yourself. It's already happening in the background.
That means no more scrambling to adjust entries or double-check formulas. The software keeps your balances accurate without the extra work.
Here’s what you get with automation:
- Faster close. Entries post automatically as months roll on.
- More accuracy. Automation doesn’t forget an entry or mistype details.
- Real-time visibility. Reports show exactly what’s expensed and what’s left.
Prepaids are only one part of the balance sheet. But when automation handles them, you free up time and cut risk. Most of all, you get to focus on more important work while having confidence in your numbers.
Getting Prepaid Expenses Right on the Balance Sheet
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Prepaid expenses don’t seem like such a big deal. In theory, you just have to keep them as assets until you use them up. Then, they move to the income statement for that period.
But with everything else your team has to do, it’s easy to forget. And one missed entry can cause significant delays in your month-end close.
Finance leaders recognize that balance sheet clarity comes from a reliable system. With automation, prepayments flow seamlessly from assets to expenses at the right period.
Modern software does the tedious and repetitive work for you. It supports your team so you can close faster and trust your finances better.
Automation ensures you get prepaid expenses right on the balance sheet every single time.
Ready to see it in action? Book a demo with us!