What Does Prepaid Mean in Accounting?


In accounting, a Prepaid account represents cash expended prior to goods or services being received. Examples of Prepaid accounts are Prepaid Expense, Prepaid Rent, and Prepaid Insurance. A Prepaid account is an asset. It has a normal debit balance. It is listed in the Current Asset section on the Balance Sheet.

What are Some Examples of Prepaid Accounts?

This table shows a list of common prepaid accounts businesses use to track the amounts the business prepays for future goods and services.

Prepaid RentPrepaid Insurance
Prepaid SubscriptionsPrepaid Interest
Prepaid ExpensesPrepaid Taxes
A list of common prepaid accounts used by a business to track various prepaid expenses.

What is Prepaid Rent?

Prepaid Rent represents rent paid to a landlord prior to when the rent is due. An example of prepaid rent would be a landlord requiring first and last month’s rent at the time the lease is signed. The first month’s rent would be recorded as Rent Expense while the last month’s rent would be recorded as Prepaid Rent. Prepaid Rent is an Asset. It has a normal debit balance. It increases on the debit side.

The journal entry for Prepaid Rent is:

Prepaid Rent1200
Rent Expense1200
Cash2400
A journal entry to record the payment of one month’s rent and the prepayment of one month’s rent.

When the Prepaid Rent is “used up”, an adjusting journal entry is used to move the amount out of Prepaid Rent and into Rent Expense:

Rent Expense1200
Prepaid Rent1200
A journal entry to record the payment of one month’s rent and the prepayment of one month’s rent.

If a business prepaid three months of rent, as each month passes, one month’s rent is moved from Prepaid Rent into Rent Expense. The original journal entry would be:

Prepaid Rent3600
Cash3600
A journal entry to record the prepayment of three month’s rent.

When the first month’s rent is due, an adjusting journal entry is done to move one month’s rent from Prepaid Rent to Rent Expense:

Rent Expense1200
Prepaid Rent1200
An adjusting journal entry to record Rent Expense.

After the first month’s journal entry is completed, the balance in Prepaid Rent is now $3,600 – $1,200 = $2,400.

When the second month’s rent is due, an adjusting journal entry is done to move one month’s rent from Prepaid Rent to Rent Expense:

Rent Expense1200
Prepaid Rent1200
An adjusting journal entry to record Rent Expense.

After the second month’s journal entry is completed, the balance in Prepaid Rent is now $3,600 – $2,400 = $1,200.

The final adjusting journal entry is done in the third month, bringing the balance in Prepaid Rent to zero.

What is Prepaid Insurance?

Prepaid Insurance represents insurance premiums paid to insurers in advance. An example of this is a company paying a year of insurance in advance. Prepaid Insurance is an Asset. It represents cash paid for services that have not yet been received. It has a normal debit balance. It increases on the debit side. It is listed in the Current Asset section on the Balance Sheet.

The journal entry for Prepaid Insurance is:

Prepaid Insurance2400
Cash2400
A journal entry to record the prepayment of twelve months insurance.

As the Prepaid Insurance is “used up”, an adjusting journal entry is used to move the amount out of Prepaid Insurance and into Insurance Expense:

Insurance Expense200
Prepaid Insurance200
An adjusting journal entry to record one month’s insurance expense.

This adjusting journal entry would be done each month for twelve months until the prepaid premium is “used up” and the balance is zero.

What is Prepaid Expenses?

Prepaid Expenses is an account used to track the payment in advance of any substantial prepayments for goods and services. This could include goods paid for in advance of delivery or services paid for in advance of the service being delivered. Prepaid Expense is an Asset. It represents cash paid for services or goods in the current month that will be received in a future month. It has a normal debit balance. It increases on the debit side. It is listed in the Current Asset section on the Balance Sheet.

Prepaid Expense account is used to record amounts that are paid for in one accounting period and received in another accounting period. An example of a Prepaid Expense is prepaid marketing. If a company is required to pay in advance for marketing consulting on a contract that will be completed in the next month, Prepaid Expense is used to record the prepayment. When the contract is completed the next month, the amount is moved out of Prepaid Expense and into Marketing Expense using an adjusting journal entry.

Here is the original journal entry to record the prepayment of marketing costs:

Prepaid Expense10,000
Cash10,000
A journal entry to record prepayment of marketing expense.

Here is the adjusting entry in the next month to record the receipt of the services:

Marketing Expense10,000
Prepaid Expense10,000
A journal entry to record prepayment of marketing expense.

The balance in Prepaid Expense is now zero.

How are Prepaid Expenses are Listed on the Balance Sheet

On the Balance Sheet, Prepaid accounts including Prepaid Insurance, Prepaid Rent, and Prepaid Expenses are recorded in the Current Asset section.

On the Balance Sheet, the Prepaid accounts would be listed:

Assets
Current Assets
Cash
Accounts Receivable
Prepaid Rent
Prepaid Insurance
Prepaid Expense
List of Current Assets from a sample Balance Sheet.

Caroline Grimm

Caroline Grimm is an accounting educator and a small business enthusiast. She holds Masters and Bachelor degrees in Business Administration. She is the author of 11 books and the creator of Accounting How To YouTube channel and blog. For more information visit: https://accountinghowto.com/about/

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