Examples of Prepaid Expense
The following prepaid expense entry example provides an outline of the most common prepaid expense. It is impossible to provide a complete set of examples that address every variation in every situation since there are thousands of such expenses. Prepaid Expense is future expenses that have been paid in advance. The most common examples of Prepaid expenses include Rent; Equipment paid for before use, Salaries, Taxes, utility bills, Interest expenses, etc.
Most Common Prepaid Expense Examples
Prepaid expenses refer to the payment made for the expenses that will happen in the future. E.g., salaries and taxes paid in advance, paying Rent before using any space for commercial purposes, any premiums for insurance of business, any interest/installment to be paid on using any hired equipment, any utility bills, etc.
Suppose Company A has purchased Consulting Services from another Company B and makes the payment for the Fees for the same of 1 lac per year for the next 5 Years.
In this case, Company A will show 1 Lac as yearly Expense, and 4 lacs would be shown in the Asset side of Accounting as “ Prepaid Expense,” which subsequently be recorded as Expenditure every year for the next 4 Years.
So the Journal Entry for the same will be –
Suppose a Company A pays Rent to Landlord of the Building on 31.12.2018 for the next 1 Year till 31.12.2019. The Company Follows Financial Year of Accounting. The rental paid is 100,000 per month.
In this case, Entire Money paid as Rent to the landlord will not be considered as Expenses for FY 18-19. Only Rent for the 3 month period, i.e., Jan 19-Mar 19, will be booked as Expense, and the remaining 9 months rent will be shown as Prepaid Expenses under the head Other Current Assets in the Asset Side of the Balance Sheet.
For FY 18-19
For FY 19-20
Suppose Company A pays Advance Salary to Mr. B for meeting his medical expenses for the next 6 months on 31.3.2019. Salary of Mr. B = 50,000 per month.
In this case, If Company A prepares his Annual Financial Statement as on 31st March 2019, they will record 50,000*6= 300,000 as Advance Salary paid to Mr. B under the head “ Prepaid Expenses” and will be reflected under Other Current Assets in the Balance Sheet.
Journal Entries in A’s Books in FY 18-19
In FY 19-20
Suppose Mr. A pays his Bike Insurance policy amount for a 2 Year period to avail the appropriate discount. Insurance Amt = 6,000 per year. Insurance is paid on 31.01.2019. Period of Insurance = 31.01.2019 to 31.01.2021.
In this case, Mr. A will record the 2 months payment as Insurance Exp for the FY 18-19, and the balance amount would be recorded as Prepaid Exp under Other Current Assets, which subsequently will be utilized in the next 2 Financial Years respectively.
Journal Entries in FY 18-19
Journal Entries in FY 19-20
Journal Entries in FY 20-21
There will not be any balance in Prepaid Exp A/c since the Same has been fully utilized in the 2Years period.
Telephone Expenses paid in Office Premises. Bill for the period 25-03-2019 to 24-04-2019
In this case, since the Bill period goes into another month, in FY 18-19, only 7 Days expenditure would be considered as Telephone Expense, and the balance will be recorded as Prepaid Exp for April 2019. Bill amount 30,000
Tax Liability of the Company via Advance Tax. The Projected Tax Liability of the Company is 1,00,000, and the same is paid in quarterly installments to the Income Tax authorities. After the Year-end, the Company assesses the Final Tax Liability based on the Profits earned during the year. The Final tax Liability comes out to be 1,20,000.
- In this case, the quarterly estimated Tax paid by Companies are as per the Projections and are made in advance of the Actual Tax Liability. Such Expenses are recorded as Advance Tax Paid under the Subhead Prepaid Expenses under Other Current Assets in the Balance Sheet and are hence adjusted when the Final Tax Liability is ascertained. Advance Tax amt = 1,00,000. Final Tax Liability 1,20,000
- Advance Tax paid will be reflected in the Asset side of the Balance Sheet while preparing the monthly and Quarterly Financials. However, the same will be adjusted while determining the Final Tax Liability of the Company since part portion has already been paid.
- Journal Entries while paying Advance Tax
- Journal Entries while paying Final Tax
Hence a Prepaid Expenditure is an expense-paid in one Accounting Year, but the benefits of the same are consumed in more than once Accounting Year. Only Expenses that are due and incurred in one accounting year can be debited to Profit & Loss A/c. Rest all the payments made which relate to the future should be grouped under Prepaid Expenses in the Balance Sheet.
This has been a guide to Prepaid Expense Examples. Here we discuss the most common Prepaid Expense examples along with step by step explanation. You can learn more about accounting from following articles –