Balance Sheet - Prepaid Expenses

Prepaid expenses refer to a payment where a company pays in advance for a services it is to received over a period of time.

Prepaid expenses refer to a payment where a company pays in advance for a services it is to received over a period of time.

Normally, a large companies balance sheet shows all of those various prepaid items grouped together under one figure as Prepaid Expenses or Prepayments.

For examples, A company might

1. Rent a plant and pay a one year rental in advance.

2. Pay in advance the interest of borrowing for a specified length of time.

3. Pay in advance of the insurance premium.

4. Sometime, taxes and employees salaries are paid in advance.

The full amount of the prepaid expenses would be shown on the balance sheet at the beginning of the period and each month certain amount will be deducted from corresponding prepaid expenses figure, by the end of the period, the total amount of the prepaid expenses would have been written down to nothing.

For example, the prepaid insurance premium is shown on the balance sheet at the full amount at the beginning of the period covered by the insurance and it is written down to nothing during the period covered by the premium.

Prepaid expenses is less important in stocks analysis unless it is contribute to a bit proportional of the company's total assets, then investor should look for further details information on the how the company's business is conducted and compare to industries average.

These are expenses that the company has already paid but which relate to a period in the future. They are assets because the company will receive value next year from having already paid that amount this year. A common example of a prepaid expense is business insurance. If your company's year end is December 31 and you pay your renewal on your insurance policy on November 1 for the period November 1 to the following October 31, much of that insurance expense belongs in the next year.

To account for the prepaid portion, you would multiply the total insurance payment by the amount of time that belongs in the next period and set that up as an asset. In the above example, if the insurance payment was $1,000, the prepaid portion would be ­

 

$1,000 X 304/365 = $832.88 prepaid

 

The balance of the payment (that is, $167.12) would be put in the insurance expense category in the general journal.