Prepaid Expenses in Accounting: Definition & Examples

Instructor: Tara Schofield
Prepaid expenses are a very common business activity that must be understood to effectively manage cash flow. This lesson explains when prepaid expenses are incurred and offers examples of common prepaid expenses.

What Are Prepaid Expenses?

Prepaid expenses are costs a company will have in the future or anticipate they will have down the road, which they pay for ahead of time. Prepaid expenses are common because there are many instances when it is necessary to pay for goods or services before they are received. For example, some companies require payment before a product is shipped, which is entered as a prepaid expense in the accounting records. In general, some prepaid expenses include rent, utilities, and insurance. Let's review some more examples of prepaid expenses.

Examples of Prepaid Expenses

Prepaid expenses may include services and products. Remember the thing that distinguishes them is that they are paid for before they are received or service is rendered. Let's look at some examples of prepaid services.

If you've ever needed the help of an attorney, you are likely familiar with a retainer they charge. This fee is paid in advance before they do any legal work for you. As they work on your case or handle your issues, they charge for their time and their charges reduce the amount of the retainer you prepaid with them.

Insurance is another example of a service that is a prepaid expense. You may choose to pay your business insurance on a monthly, semi-annually basis, or annual basis. You pay the appropriate amount at the beginning of the month or billing period. That payment covers the expense of your insurance for the established period of time. Each day that passes essentially reduces the amount of insurance you have prepaid for because you have used up one more day of coverage. Once that day passes, the insurance is used, and the expense has been incurred.

Now let's look at prepaid expenses for products.

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