What are prepaid expenses: Examples and key features

Anyone working with accounting or financial statements will sooner or later come across the concept of prepaid expenses — the timing difference between payment and the delivery of goods or services. In this article, we explain how the accrual method of accounting works, how prepaid expenses are recorded, and how they differ from deferred income — including clear, practical examples.

Accrual accounting: Definition

The accrual method of accounting ensures that revenues and expenses are assigned to the correct financial year, even when payment and performance occur at different times. In practice, this often happens with advance payments or delayed receipts.

To present a company’s financial performance accurately for each period, specific deferral accounts are created.

A prepaid expense arises when a company makes a payment during the current financial year for goods or services that economically belong to the next year.

• Example: A consulting service is paid for in December for work that will be performed in the following year. The expense relates to the next accounting period, but the payment has already been made in the current one.

In contrast, deferred income occurs when revenue is received in the current financial year for goods or services that will be delivered in the next.

• Example: A company receives payment in December for a service that will not be provided until January of the following year.

Difference between prepaid expenses and deferred income

The importance of prepaid expenses for businesses

Prepaid expenses play a central role in accounting to ensure financial transparency and accuracy. They enable companies to prepare economically correct and traceable financial statements under the accrual method of accounting.

Accurate Profit Determination: Expenses are allocated to the correct financial year, ensuring that the actual profit for each period is reported correctly.

Correct Cost Allocation: Payments made in advance (e.g., rent or insurance premiums) do not unnecessarily affect the current year’s results.

Precise Financial Planning: Through accurate timing of expenses and revenues, companies gain a realistic view of their ongoing obligations and budgets.

Prepaid Expenses: Example – Insurance

A typical example of prepaid expenses is the advance payment of an insurance premium.

If a company pays an annual premium for liability insurance in December 2025 that covers the period from January to December 2026, the expense economically belongs to 2026, not to 2025.

To keep the financial statements as of December 31, 2025, accurate, the amount (in this case, the entire premium) is recorded as a prepaid expense on the asset side of the balance sheet. The expense is then recorded in the income statement in 2026, when it actually applies.

Prepaid Expenses: Example – Rent payments

A company pays office rent in December 2025 for the first quarter of 2026. Although the payment is made in the current financial year, the expense belongs to the next year.

The prepaid rent is shown as a prepaid expense (an asset) in the balance sheet. In 2026, the rent is recognised as an expense. This ensures that the profit for 2025 is not distorted by future costs.

Prepaid expenses: Example – Salaries

A company pays salaries on December 20, 2025, for work performed in January 2026. Even though the payment occurs in the current year, the expense belongs to the next year because the work will be performed later.

The amount paid is recorded as a prepaid expense on the balance sheet until December 31, 2025, and is reported as an expense in the income statement in January 2026.

How companies can optimise their prepaid expense management

By implementing clear, automated processes and regular reviews, companies can reduce manual errors and make year-end closing more efficient.

Automating accounting processes

Accurate and efficient expense deferral is easiest when companies automate their cash flow. Modern accounting software allows payments to be tagged or categorised intelligently so that prepaid expenses are automatically identified and properly recorded.

This automation is particularly useful for recurring payments such as rent, insurance, or software subscriptions. It not only reduces manual work and the risk of errors but also saves time during financial closing. The result is greater transparency, improved planning, and significant relief for the finance department.

Reviewing contracts and cost structure

Effective management of prepaid expenses begins with a clear overview of ongoing contracts and recurring payments. Companies should regularly review which services are paid in advance — for example, insurance, software licenses, or maintenance contracts — and assess whether the payment terms make economic sense.

Such reviews often reveal opportunities for savings or optimisation in contract duration and payment conditions. Better expense management and control of corporate credit card expense management not only simplify accounting but also strengthen financial planning overall.

Establishing clear policies and processes

Companies should define which types of advance payments need to be deferred, who is responsible for recording them, and how frequently these entries should be reviewed.

Standardised procedures — such as year-end checklists or fixed approval routines — minimise errors and improve transparency. Close collaboration between accounting, controlling, and operational departments also helps identify relevant payments early.

Improving documentation

The clearer it is when payments were made and which periods they relate to, the easier it becomes to record them correctly. Digital tools and accounting systems now make it possible to capture invoices directly, add metadata, and automatically assign them to the correct accounting period.

Even simple measures, such as systematically photographing or scanning incoming invoices, greatly enhance traceability. This way, even with numerous individual transactions, companies maintain an overview and can document prepaid expenses reliably.

Using forecasts for better financial planning

Forward-looking financial planning supports not only controlling but also a structured approach to managing prepaid expenses. Regular forecasts for rent, insurance, and other costs help companies plan in advance which payments need to be deferred.

This not only simplifies the creation of prepaid expense entries but also improves liquidity planning and budget control. When future obligations are tracked transparently and updated regularly, expense peaks can be managed more effectively and financial risks identified early.

amnis: For integrated accounting

amnis is the smart complement to your traditional bank — combining global banking, expense management, and accounting automation in a single platform. Companies benefit from a multi-currency account supporting over 20 currencies, physical and virtual business debit cards for all employees, and free international transfers within Switzerland, the EU, the United Kingdom, and the United States.

Thanks to seamless bexio integration and powerful API connections, incoming payments, expenses, and currency exchanges are automatically categorised and booked. With receipt uploads via the mobile app and AI-powered tools such as doc2pay and mail2pay, invoices and receipts are instantly recognised, matched, and processed — entirely without manual effort.

This reduces the workload for finance teams by up to 50%, ensures complete visibility at all times, and frees up valuable time for what truly matters.

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