Prepaids are expenditures that have been paid but have not yet been used up or have not yet expired. The cost of these expenses is allocated to the same period in which revenue is generated which is known as the matching principle. The amount of Prepaids that have not yet expired is reported on a company’s Balance Sheet as an asset. As the amount expires, the asset is reduced and an expense is recorded for the amount of the reduction. The Balance Sheet reports the unexpired amount and the Income Statement reports the expired amount. The amount reported on the Income Statement should be the amount that pertains to the period.

A common prepaid item is property taxes. Property taxes are due at the same time every year in July but they represent the property taxes for the calendar year. Unless you have a December year-end date, there is a mismatch of the property taxes expense. The difference is allocated to Prepaid Expenses. The prepaid property tax will then be reduced by the amount that is allocated to property taxes expense in the correct period.

Another common prepaid item is insurance. Since the insurance company requires payment in advance for the upcoming one-year period, the amount paid is often allocated to Prepaids. The prepaid insurance should then be reduced by the monthly expense and allocated to insurance expense on the Income Statement.