Prepaid expenses journal entry helps record any advance payment made for services or benefits that a business will receive in the future. When a business pays money for things like rent, insurance, or subscriptions before they are due, we do not treat that amount as an expense right away. Instead, we treat it as an asset. This entry makes sure the business records the transaction properly in the accounting books.Prepaid expenses journal entry helps record money paid in advance, and we show it as an asset at first. Later, when the service is received, we convert that asset into an expense.Many businesses pay in advance for services they need regularly. These may include rent, insurance, advertisement costs, or maintenance services. You cannot show all of these as expenses in the month they are paid. That would make the profit and loss report wrong. You must divide the total amount and show only the portion that belongs to the current period. This is where Prepaid expenses journal entry becomes important.

What are Prepaid Expenses?

Prepaid expenses are payments made in advance for goods or services. You make these payments before the service is received. You do not record them as expenses right away. You first record them as current assets. Later, when the benefit is used, you record the expense.

When a business pays for a service or benefit that it has not yet received, it is called a prepaid expense. The business has paid now, but it will use the service in the coming months.

Let us take a simple example. A company pays ₹60,000 for a one-year insurance policy in April. This ₹60,000 is not an expense for April only. The benefit of this insurance will last for 12 months. So, each month, the company will record ₹5,000 as an insurance expense. The remaining balance will stay as a prepaid expense.

Common examples of prepaid expenses:

• Prepaid rent
  
• Prepaid insurance
  
• Prepaid advertising
  
• Prepaid telephone charges
  
• Prepaid maintenance contracts
  
• Prepaid subscriptions
  

Why Do We Use Prepaid Expenses?

Businesses want to show the correct income and expense in each period. If they record all expenses at the time of payment, their profit or loss will not be correct. Prepaid expenses help split the expense and match it with the correct time period.

That is why prepaid expenses follow the Matching Principle of accounting. You must record the expense in the same period when the benefit is received.

Format of Prepaid Expenses Journal Entry

First we have to record the payment and then adjust it every month.

Step 1 – Initial Journal Entry (At the time of payment)

At the time of payment, the company has not received the benefit yet. So, it treats the amount as an asset.

Date	Particulars	L.F.	Debit (₹)	Credit (₹)
01/04/2025	Prepaid Insurance A/c Dr.     To Bank A/c(Being insurance premium paid in advance for 1 year)		60,000	60,000

Step 2 – Adjusting Entry (At the end of each month)

At the end of every month, a portion of the benefit is used. Now, we must transfer that amount from prepaid expense to actual expense.

Date	Particulars	L.F.	Debit (₹)	Credit (₹)
30/04/2025	Insurance Expense A/c Dr.       To Prepaid Insurance A/c(Being monthly portion of insurance used)		5,000	5,000

You must pass this adjusting entry every month until the full amount is used.

Accounting Rules for Prepaid Expenses Journal Entry

Accounting follows certain rules. To write the prepaid expenses journal entry correctly, you must follow the basic rules of double-entry bookkeeping.

Rule 1: At the time of payment

At the time of payment, you increase an asset (prepaid expense). So, you debit the prepaid expense account. You decrease cash or bank, so you credit the bank.

Rule followed:

• Debit what comes in (Prepaid asset)
  
• Credit what goes out (Cash/Bank)
  

Rule 2: At the time of adjustment

When the time comes to use the service, you must record it as an expense. So, you debit the expense account and credit the prepaid asset account.

Rule followed:

• Debit all expenses
  
• Credit what goes out (Asset used)
  

These rules help in matching expenses with income. You cannot record all payments as expenses in one month. That gives the wrong financial picture. Adjusting entries help correct that.

Prepaid Expenses in Financial Statements

Once you write the prepaid expenses journal entry, you must show it correctly in your financial statements.

Where to show prepaid expenses?

1. Balance Sheet: Show unused portion as a Current Asset under the heading “Other Current Assets”

2. Profit and Loss Account: Show used portion as Expense in the relevant head.

Let’s say you paid ₹1,20,000 rent for the year. You adjust ₹10,000 every month.

• In April:
  
  • ₹10,000 goes to P&L as Rent Expense
    
  • ₹1,10,000 shows in Balance Sheet as Prepaid Rent
    

This method follows accrual accounting and gives a true picture of financial health.

Relevance to ACCA Syllabus

Prepaid expenses journal entry is an essential topic in FA (Financial Accounting) and FR (Financial Reporting) under ACCA. It helps students understand how to record and adjust entries as per the matching principle and accrual accounting. ACCA students must accurately classify and adjust prepaid items in financial statements to ensure fair presentation.

Prepaid Expenses Journal Entry ACCA Questions

Q1. What type of account is a prepaid expense initially recorded as?
A) Liability
B) Equity
C) Asset
D) Expense
Ans: C) Asset

Q2. Under which accounting principle are prepaid expenses adjusted over time?
A) Cost principle
B) Matching principle
C) Realization principle
D) Materiality principle
Ans: B) Matching principle

Q3. What journal entry is passed when prepaid rent is used at the end of a month?
A) Rent Expense A/c Dr. To Bank A/c
B) Prepaid Rent A/c Dr. To Rent Expense A/c
C) Rent Expense A/c Dr. To Prepaid Rent A/c
D) Bank A/c Dr. To Rent Expense A/c
Ans: C) Rent Expense A/c Dr. To Prepaid Rent A/c

Q4. In which section of the balance sheet do prepaid expenses appear?
A) Current liabilities
B) Current assets
C) Non-current assets
D) Retained earnings
Ans: B) Current assets

Q5. What happens to prepaid insurance over time?
A) It increases liability
B) It turns into income
C) It becomes an expense
D) It is written off
Ans: C) It becomes an expense

 Relevance to US CMA Syllabus

In US CMA Part 1: Financial Planning, Performance, and Analytics, candidates must understand how to prepare and adjust journal entries. Prepaid expenses journal entry is necessary to correctly classify and allocate expenses across periods to reflect accurate budgeting, reporting, and performance evaluation.

Prepaid Expenses Journal Entry CMA Questions

Q1. What is the correct entry when a business prepays ₹24,000 for a 12-month insurance policy?
A) Insurance Expense A/c Dr. To Cash A/c
B) Prepaid Insurance A/c Dr. To Cash A/c
C) Insurance Payable A/c Dr. To Cash A/c
D) Cash A/c Dr. To Prepaid Insurance A/c
Ans: B) Prepaid Insurance A/c Dr. To Cash A/c

Q2. How much monthly expense should be recorded for a ₹24,000 prepaid insurance over 12 months?
A) ₹1,000
B) ₹2,000
C) ₹3,000
D) ₹4,000
Ans: B) ₹2,000

Q3. When is the adjusting entry for prepaid expenses passed?
A) At the time of purchase
B) At the time of use
C) At the end of the accounting period
D) When cash is available
Ans: C) At the end of the accounting period

Q4. In cost management, why is correct prepaid expense treatment important?
A) It reduces liabilities
B) It improves cash flow
C) It ensures expense accuracy per period
D) It increases equity
Ans: C) It ensures expense accuracy per period

Q5. Prepaid advertising for the next 3 months is:
A) An expense for the current period
B) A capital item
C) A non-current asset
D) A current asset
Ans: D) A current asset

 Relevance to US CPA Syllabus

US CPA FAR (Financial Accounting and Reporting) requires candidates to apply accrual principles, including correct treatment of prepaid expenses journal entry. CPA aspirants must recognize how prepaid items shift from assets to expenses, affecting both income statements and balance sheets in accordance with GAAP.

Prepaid Expenses Journal Entry CPA Questions

Q1. Under US GAAP, what is the correct entry to record a ₹60,000 prepaid insurance for a year?
A) Insurance Expense A/c Dr. ₹60,000
B) Insurance Payable A/c Dr. ₹60,000
C) Prepaid Insurance A/c Dr. ₹60,000
D) Cash A/c Dr. ₹60,000
Ans: C) Prepaid Insurance A/c Dr. ₹60,000

Q2. What type of adjusting entry converts prepaid expenses into actual expenses?
A) Accrued revenue
B) Deferred expense
C) Accrued expense
D) Deferred income
Ans: B) Deferred expense

Q3. If a company forgets to adjust prepaid expenses, what is the effect?
A) Expenses understated, Assets overstated
B) Assets understated, Liabilities overstated
C) Expenses overstated, Income understated
D) Equity understated
Ans: A) Expenses understated, Assets overstated

Q4. When adjusting prepaid expenses, which account is credited?
A) Expense Account
B) Asset Account
C) Revenue Account
D) Capital Account
Ans: B) Asset Account

Q5. Which of the following reflects the impact of adjusting a prepaid rent account?
A) Reduces liabilities
B) Increases equity
C) Increases expenses
D) Reduces revenue
Ans: C) Increases expenses

Relevance to CFA Syllabus

In CFA Level I: Financial Reporting and Analysis, prepaid expenses are part of understanding how accruals affect financial performance and ratios. Candidates must know how prepaid items alter asset balances, profit margins, and cash flow from operations under both IFRS and US GAAP.

Prepaid Expenses Journal Entry CFA Questions

Q1. Prepaid expenses appear on the balance sheet as:
A) Non-current liability
B) Deferred revenue
C) Current asset
D) Intangible asset
Ans: C) Current asset

Q2. What happens when a company fails to adjust prepaid expenses?
A) Overstates cash flow
B) Overstates expense
C) Overstates net income
D) Understates liabilities
Ans: C) Overstates net income

Q3. When prepaid expenses are consumed, how are they reported?
A) As an asset
B) As a revenue
C) As a liability
D) As an expense
Ans: D) As an expense

Q4. How does prepaid rent affect the cash flow statement?
A) Operating outflow
B) Financing outflow
C) Investing inflow
D) No impact
Ans: A) Operating outflow

Q5. Under IFRS, how are prepaid expenses amortized?
A) Fully in the purchase month
B) Equally over the benefit period
C) Based on estimated market value
D) Not amortized
Ans: B) Equally over the benefit period