Prepaid Expense is NOT an Expense
Similar to Deferred Revenue, the Prepaid Expense account can be confusing at first
glance. Even though it has the word ‘expense’ as part of its account name, it is not an
expense account. Prepaid Expense is an asset account. It represents an amount that
has been prepaid by the business, and thus the business now has the right to receive
goods or services in the future. Prepaid expense will be converted into an expense at a
later date, when the goods or services are provided. This, again, is an example
The process for recording prepayments and the use of the related benefits is similar to
the process we just learned about for recording payments received in advance.
Let's continue with the example where Bikram Yoga Natick prepays $2,400 for one year
of insurance on January 1, 2013. The initial journal entry on January 1, 2013 records a
debit to Prepaid Insurance (an asset) and a credit to Cash, as shown below. This
increases the balance in Prepaid Insurance and decreases the balance in Cash.
Prepaid Insurance is an asset because by prepaying for an entire year of insurance,
Bikram Yoga Natick is now entitled to receive insurance benefits throughout the year.
Companies may sometimes call an account like this Prepaid Insurance Expense, or
simply, Prepaid Expenses. Even though the word "Expense" may be in the account
name, remember that prepaid expenses are actually assets.