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.

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.