Prepaid Expense

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DEFINITION of 'Prepaid Expense'

A type of asset that arises on a balance sheet as a result of business making payments for goods and services to be received in the near future. While prepaid expenses are initially recorded as assets, their value is expensed over time as the benefit is received onto the income statement, because unlike conventional expenses, the business will receive something of value in the near future.

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BREAKING DOWN 'Prepaid Expense'

Due to the nature of certain goods and services, they must be prepaid expenses. For example, insurance is a prepaid expense, because the purpose of purchasing insurance is to buy proactive protection in case something unfortunate happens. Clearly, no insurance company would sell insurance that covers the occurrence of an unfortunate event, after the fact, so insurance expenses must be pre-paid.

An example of expensing prepaid expenses would be if a company had a one-year insurance policy cost of $1200. As each month elapses, $100 of prepaid insurance would be expensed to the income statement until the account is empty at the end of the year.

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RELATED FAQS
  1. How do prepaid expenses affect liquidity ratio calculations?

    Prepaid expenses generally increase the value of liquidity ratios because a prepaid expense is categorized as a current asset ... Read Full Answer >>
  2. How are prepaid expenses recorded on an income statement?

    Prepaid expenses are not recorded on an income statement. When the prepaid expense becomes due, the expense is recognized ... Read Full Answer >>
  3. What is the advantage of calculating accrued expenses over prepaid expenses?

    An accrued expense, or an accrued liability, is an expense that has not yet been paid for. It is paid for after it is recorded ... Read Full Answer >>
  4. What are the differences between deferred expenses and prepaid expenses?

    Companies have the option to pay expenses forward for certain costs associated with doing business, creating an accounting ... Read Full Answer >>
  5. Who benefits the most from prepaid expenses?

    Prepaid expenses benefit both businesses and individuals. Prepaid expenses are the types of expenses that are bought or paid ... Read Full Answer >>
  6. What is the difference between the current ratio and the acid test ratio?

    The acid-test ratio and the current ratio are two commonly used methods to measure the liquidity and solvency of a company. ... Read Full Answer >>

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