What is Prepaid Expense Amortization? Meaning & Definition

It aligns with the matching principle in accounting, which ensures that expenses are recognized in the same period as the related revenue or benefits. When a company makes a prepayment, such as paying insurance premiums or amortization of prepaid expenses rent in advance, it is classified as a prepaid expense. In this scenario, we would record a prepaid asset at the beginning of the contract and the expense of the subscription would be realized over the course of the year.

• The prepaid expense is considered an asset because it represents a future economic benefit that the company has already paid for.
• As a rule of thumb, prepaid expenses have been paid but are yet to be realized whereas accrued expenses are incurred but yet to be paid.
• In this fiscal period, they have an impact and a requirement for compliance with accounting’s matching principle.
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• As it is impossible to include a comprehensive list of every possible prepaid expense, it is more useful to understand the concept in order to identify transactions creating prepaid expense assets.

Consider ABC Corporation, which leased a new office space in New York City in 2023. As per the lease terms, the company is required to pay the full year’s rent in advance, on the starting day, amounting to $36,000. Prepaid rent refers to the advance payment made by a tenant to a landlord for renting a property. It represents the portion of rent that has been paid in advance for a future period.

What Other Calculations are Involved in Prepaid Expense Amortization?

Initially, the prepaid expense is recorded as a prepayment in a current account on the company’s balance sheet. As the expense is utilized or consumed, it is gradually reduced to zero following an amortization schedule. These are considered assets in accounting because they represent future economic benefits for a business.

Hence, tax on an advance expense can only be deducted in the year to which it applies. Prepaid expenses represent expenditures that have not yet been recorded by a company as an expense, but have been paid for in advance. In other words, prepaid expenses are expenditures paid in one accounting period, but will not be recognized until a later accounting period. Prepaid expenses are initially recorded as assets, because they have future economic benefits, and are expensed at the time when the benefits are realized (the matching principle). Another advantage is that amortizing prepaid expenses helps businesses to better allocate their resources.

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This is because that prepayment is an asset having value beyond the present time. As a result, businesses use prepaid expense amortization as a way to spread prepaid expenses over the accounting periods in which the business can derive value from them. When a company prepays for an expense, it is recognized as a prepaid asset on the balance sheet, with a simultaneous entry being recorded that reduces the company’s cash (or payment account) by the same amount. Most prepaid expenses appear on the balance sheet as a current asset unless the expense is not to be incurred until after 12 months, which is rare. In short, these expenses are payments made in advance for goods or services to be received in the future. Expenses that are used to make payments for goods or services that will be received in the future are known as prepaid expenses.