Prepaid expenses are those which are paid but whose service has not obtained from service provider. For example, you have paid one month advance rent of your business shop before using 30 days for your business. This one month advance rent will be prepaid expense. Recording all prepaid expenses is very important. If you have added it in normal expense in the end, you have to pass adjustment entry for deducting this from normal expense because this expense will be of next year not this year.
1. When you paid the expense in advance
|Service Provider or Prepaid Account – Debit|
Bank Account or Cash Account – Credit
Before getting service if we pay any expense to service provider, it will just loan to service provider. Service provider will be receiver. So, we will debit service provider account. We will credit the bank account or cash account because when we pay the expense, our money will go outside the business.
In the Balance Sheet, we will show service provider for expense as our current asset.
2. When Service Provider provides us the service before end of financial year.
|Expense Account – Debit |
Service Provider or Prepaid Expense Account – Credit
2. When we have added it in normal expense. At the end of year, we will pass the adjustment entry.
Prepaid Expense or Service Provider for Expense Account – Debit
Expense Account – Credit
For example, we have entered Rs. 7,000 in normal rent account but it was the prepaid rent for next financial month. So, following entry will be passed.
|Prepaid Rent Account – Rs.7,000 Debit |
Rent Account – Rs.7,000 Credit
In the profit and loss account,we will deduct Rs. 7,000 from total rent. We also show Prepaid rent account in the asset side of balance sheet.