Principles of Accounting: Prepayments and the Financial statements

• A prepayment is when an amount is paid before it is due
• In accounting there are two types of prepayments:
• Prepaid expenses and
• Prepaid income

Prepaid expenses

• This is when the business prepays an expense
• Examples are:
  • When a business pays rent payable in advance or
  • When it pays insurance expenses in advance
• Only the expense for the period in question must be recorded in the Income statement
• The excess amount must be carried forward and expensed in the period to which it relates
• For example the rent for the business’s premises is $10 000 per year
• During the month of October 20×6 the business makes a payment of $7500
• Another payment of $5000 is made on 22 December
• The business’s trading period ends on 31 December
• These transactions would be recorded in the books as follows:

• In other books the narration Balance c/d and Balance b/d are replaced using Prepaid c/d and Prepaid b/d respectively
• As shown below:

• As clearly shown only the amount attributable for the period is transferred to the Income statement
• If you not asked to prepare the expense account you can use the short cut method in the Income statement
• Prepaid amounts are subtracted from the expense amount
• Prepaid expenses are shown under current assets beneath debtors
• The order of the current assets list becomes:
  • Stock
  • Debtors
  • Prepaid expenses
  • Bank
  • Cash

Prepaid Income

• This is when the business receives income in advance
• An example is when the business receives rent when it rents out extra space
• If the business receives this income in advance it becomes prepaid income
• Only the income pertaining to the current period is shown in the Income Statement
• The excess amount is carried forward
• For example:
• The rent receivable for the business is $4000 per year
• The business receives a payment of $5000 on 14 July 20×6
• The entries to record this would be as follows:

• Prepaid income is deducted from income paid each period
• Prepaid income is shown under current liabilities since the prepaid monies involved belong to outsiders

To access more topics go to the Principles of Accounts Notes.