BATT#8: What is a Prepaid Expense?

Hey all!  Time for a new week of BATTs.  Today we’re going to learn what a prepaid expense is and how we deal with them.

A prepaid expense is anything where you have paid in advance of receiving a good or service.  A common example is an insurance premium.  If you pay annually, you pay at the beginning of the policy term for coverage over the next twelve months.  Therefore, even though you have paid the full premium up front, it still has future value over the next year.

It’s the future value component that fundamentally distinguishes a prepaid from a regular expense.  Because of that future value, the correct treatment is to capitalize the expense as a current asset on the balance sheet.  Then, you’ll adjust it at each reporting period to recognize the expense incurred and reduce the asset to the remaining value left.

What distinguishes this from capital or long term assets is typically you’re not seeing these extend past twelve months, or the current period.

It’s important to note that this is generally how you treat such expenses under Canadian tax, so while the amounts are typically not massive, it is important to adjust them properly.

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