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Financial Accounting · Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income

Prepaid Expenses (Prepayments) Explained for ACCA FA

Updated 11 October 2026 · Fact-checked

A prepaid expense is a cost you have paid for a benefit that falls after the reporting date. You split the payment: the part used up in the year goes to profit or loss, and the unused part is carried forward as a current asset. The entry is Dr Prepayments, Cr Expense.

Understand Prepaid Expenses (Prepayments)

Businesses often pay for things before they use them. Insurance, rent and subscriptions are typical. If a payment covers a period that runs past the year end, only part of it belongs to this year.

The accruals (matching) concept says expenses belong in the period in which the benefit is received, not the period in which cash leaves the bank. So you must remove the part of the payment that relates to next year from this year's expense.

The unused part is not lost. The business has a right to receive a future service, such as insurance cover. That right is an asset, so it is shown as a prepayment within current assets in the statement of financial position (often grouped with trade receivables as 'trade and other receivables').

In the next period the prepayment is reversed. The opening prepayment becomes part of next year's expense: Dr Expense, Cr Prepayments. This is why the expense account in the new year starts with a debit for the amount brought forward.

Compare with an accrual. An accrual is an expense incurred but not yet paid, so it is a liability. A prepayment is an expense paid but not yet incurred, so it is an asset.

Key formulas to remember

Prepayment amount
Prepayment = Total amount paid × (months unexpired ÷ total months covered)
Unexpired months are those after the reporting date. Use days or months, whichever the question gives.
Expense for the year (ledger)
Statement of profit or loss expense = Cash paid in year − opening accrual + closing accrual + opening prepayment − closing prepayment
Opening prepayment is added because it is used up this year. Closing prepayment is deducted because it belongs to next year.
Year-end journal
Dr Prepayments (current asset) Cr Expense account
Reduces this year's expense and creates the asset.
Opening reversal journal
Dr Expense account Cr Prepayments
Done at the start of the next year. The prior year's prepayment is now used up.

How to solve Prepaid Expenses (Prepayments) questions

Use this method for any prepayment question, whether it asks for a journal, an expense figure or a statement of financial position balance.

  1. 1Find the total amount paid and the exact period it covers.
  2. 2Find the reporting date and count how many months or days of the cover fall after it.
  3. 3Calculate the prepayment: amount × unexpired period ÷ total period.
  4. 4Calculate the expense for the year: amount paid less the prepayment, plus any opening prepayment brought forward.
  5. 5Post the journal: Dr Prepayments, Cr Expense account.
  6. 6Show the prepayment under current assets, and the reduced expense in profit or loss.
  7. 7Check the answer: expense plus prepayment should equal the cash paid (adjusted for any opening balance).

Quickest way: Unexpired months shortcut

When to use it: Use this for multiple choice and number entry questions where one payment covers a period crossing the year end.

  1. Count the months after the year end that the payment covers.
  2. Divide the payment by the total months to get a monthly cost.
  3. Multiply by the unexpired months. This is the prepayment.
  4. Subtract it from cash paid to get the expense.
  5. If an opening prepayment exists, add it to the expense.

Common mistakes in Prepaid Expenses (Prepayments)

  • Counting the months already used instead of the unexpired months

    You rush and take the first period you see in the question.

    Fix: Draw a quick timeline. Mark the year end and count only the months to the right of it.

  • Treating a prepayment as a liability

    It is confused with an accrual because both are year-end adjustments.

    Fix: Remember: prepaid means paid ahead, so you hold a right. It is a current asset.

  • Reversing the journal (Dr Expense, Cr Prepayments) at the year end

    You memorise the entry without checking its effect on profit.

    Fix: Ask whether profit should go up. A prepayment reduces this year's expense, so credit the expense.

  • Forgetting the opening prepayment when finding the expense

    The opening balance is given as a side detail and is overlooked.

    Fix: Always check for a brought-forward balance. Add the opening prepayment to the cash paid, then deduct the closing prepayment.

  • Using the wrong number of months in the total period

    The payment date and the cover start date are different, for example payment on 1 October covering from 1 November.

    Fix: Use the dates the cover starts and ends, not the date of payment.

Worked examples

Example 1

A company has a year end of 31 December 20X5. On 1 October 20X5 it paid an annual insurance premium of $2,400 covering 1 October 20X5 to 30 September 20X6. There was no opening prepayment. Calculate the insurance expense for the year and the prepayment at 31 December 20X5.

Show the solution
  1. Total period covered is 12 months. Cost per month is $2,400 ÷ 12 = $200.
  2. Cover used up to the year end is October, November and December, which is 3 months.
  3. Unexpired months after the year end are 12 − 3 = 9.
  4. Prepayment = $200 × 9 = $1,800.
  5. Expense = $2,400 − $1,800 = $600.
  6. Check: $600 + $1,800 = $2,400, which equals cash paid.
  7. Journal: Dr Prepayments $1,800, Cr Insurance expense $1,800.

Answer: Insurance expense $600; prepayment $1,800 shown in current assets.

Example 2

At 1 January 20X6 a business had a rent prepayment of $1,500. During the year ended 31 December 20X6 it paid rent of $9,000. At 31 December 20X6 the rent paid in advance was $2,000. Calculate the rent expense for the year.

Show the solution
  1. Start with cash paid in the year: $9,000.
  2. Add the opening prepayment, because that rent relates to 20X6: $9,000 + $1,500 = $10,500.
  3. Deduct the closing prepayment, because it relates to 20X7: $10,500 − $2,000 = $8,500.
  4. Ledger check: the rent account has opening debit $1,500, bank debit $9,000, closing credit (prepayment c/d) $2,000. The balancing charge to profit or loss is $8,500.

Answer: Rent expense for the year is $8,500; the closing prepayment of $2,000 is a current asset.

Exam tips

  • Read the year end date first, then the cover period. Most errors come from miscounting unexpired months.
  • In multiple response questions, check carefully which statements correctly describe a prepayment (an asset) and an accrual (a liability).
  • In number entry questions, write down the opening balance adjustment before you calculate. Missing it is the most common lost mark.
  • In Section B ledger tasks, balance the expense account and check it equals the profit or loss charge you computed separately.
  • Always sanity check: the expense should be lower than cash paid when the prepayment grows.

Practice questions from Accrued expenses (accruals), prepaid expenses (prepayments), accrued income and deferred income

Prepaid Expenses (Prepayments) in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Prepaid Expenses (Prepayments): frequently asked questions

What is the journal entry for a prepaid expense?

At the year end, debit Prepayments (current asset) and credit the relevant expense account with the unexpired amount. At the start of the next year, reverse it: debit the expense and credit Prepayments.

How do I calculate a prepayment for insurance?

Divide the premium by the number of months covered to get a monthly cost. Multiply by the months that fall after the reporting date. That figure is the prepayment.

What is the difference between accruals and prepayments?

An accrual is an expense incurred but not yet paid, so it is a current liability and increases the expense. A prepayment is an expense paid but not yet incurred, so it is a current asset and decreases the expense.

Where does a prepayment appear in the financial statements?

It appears in current assets in the statement of financial position, usually within trade and other receivables. The expense in the statement of profit or loss is shown net of the prepayment.