What Are Prepayments - Definition - Meaning - Examples - Explanation

Prepayments are Advance Payments or Deferred Expenses paid in advance against which benefits or services are still not received by the business during or at the end of accounting. Prepayments are existed because of Accrual Basis of Accounting System. Prepayments are also known as Deferred Expenses. These include both Prepaid Expenses and Deferred Expenses or Expenditures that can be expired for more than one year or not.

For Example, When the company paid advance rent to rental company for five months of Rs. 100000, then it is called Prepayments (Here Prepayment Rent) against which services like housing facility, car facility, etc., are still not received by the business during the accounting period.

Prepayments are categorized under both Current Assets and Non Current Assets / Fixed Assets on Balance Sheet if these are expired for more than one year.

Prepayments Journal Entry

When these are incurred, we debit it and credit Cash account. At the end of accounting period, the portion of prepayments against which the services or benefits had received transferred to relevant expense account and the remaining amount of prepayments will be transferred to Balance Sheet.

Let’s us consider our above example, if we paid Rent Prepayment or Prepaid Rent for 6 months of Rs. 100000 (Rs. 20000 Each) on 1^st October, 2017, then following Journal Entry at the time of payment (using Balance Sheet Method)

                                        Rent Prepayment a/c   100000

                                                                          Cash a/c   100000

(Make Prepayments To Rental Company)

On 31^st December, 2018, the portion of Rent Prepayment (Here Prepaid Rent) against which the services are received are transferred to rent expense and remaining Rent Prepayment (Unexpired Rent) are transferred to Balance Sheet, we do so by recording following Adjusting Entry as shown below:

                                       Rent Expense a/c       60000

                                                                    Prepayment Rent a/c     60000

(Portion of Prepayment Rent Is Transferred to Rent Expense Account)

Here Prepayment Rent 1^st October To 31^st December 2017 = 3 X 20000 = Rs. 60000

The remaining amount of Rs. 40000 for Prepayment Rent will go to Balance Sheet As a Current Asset against the benefits or services are still not received by the business at the end of accounting period.

Prepayment T Account is prepared to record Business Transactions related to Prepayment Accounts for the accounting period.

The normal balance of Prepayment account is debit. However, when it incurs we debit it and when it expires we credit it.

So, Prepayments are advance payments or expenses paid in advance or deferred expenses or expenditures that may be within the one year or more than one year.