Whether you are a finance student or have simply developed an interest to manage your accounts in business, it becomes crucial to understand the technical jargons that define your company’s Balance sheet.
One common component that one can be easily confused is the difference between prepaid expenses and accrued expense.
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It becomes crucial to realize the difference between these two expenses on the basis of:
- – the timing of the expenses incurred
- – the financial statements of a company
Hence the difference needs to be highlighted in detail, to avoid confusions in the balance sheet of your company.
Also read: Expense Management Best Practices
How to record prepaid expenses?
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Prepaid expenses are expenses incurred because of payments that have been made in advance. Though expenses are usually recorded as a liability in the balance sheet but prepaid expenses are a slight deviation from the theory because the privileges can be incurred in the future.
An example of prepaid expense is an insurance premium. Though insurance payment is an expense but however the prime reason for undertaking an insurance coverage is to receive future benefits from this expense.
Prepaid expenses are always recorded in the current asset of the balanced sheet. Therefore when the insurance premium is paid in full at the beginning of the insurance coverage, the prepaid expense account for insurance is debited and the cash account is credited in the balance sheet.
However, at the end of every quarterly Balance Sheet, it is important that the prepaid expense account for insurance is credited and the insurance expense account is debited.
Other examples of prepaid expenses include: advance payment of rent, supply orders in stock, tax paid in advance by corporations prior to payment of the actual tax liability.
How to record Accrued expense?
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Accrued expense is the exact opposite of prepaid expense. Where prepaid expenses are included in the current asset, accrued expenses are included in the current liability. Accrued expenses are expenses that have been incurred but the payment has not been made yet.
An example of accrued expense includes: Goods received but no invoice has been delivered for payment. To record this transaction, the accrued expense is recorded as a credit in the liability account and the office supplies expense is recorded as a debit in the Balance sheet.
However at the end of the quarter when invoice payment is made, the entry is simply reversed where office supplies expense is credited and accrued expense liability account is debited.
Therefore we can conclude that prepaid and accrued expenses are mirror reflections to each other. When prepaid expense is considered as an asset, accrued expense is a liability in the financial statement.
Using an expense management tool like Invoicera is the key to manage all kinds of business expenses well. The tool is helpful recording expenses and when they occur generating detailed expense reports for financial analysis.
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