Fundamentals of Financial and Cost Accounting · Adjustment Entries and Rectification of Errors

Outstanding and Prepaid Expenses: Journal Entries and Treatment

Updated 10 October 2026 · Fact-checked

An outstanding expense is an expense that has become due for the year but is not yet paid. A prepaid expense is paid in advance for a future period. Add outstanding amounts to the expense in the P&L account and show them as a liability. Deduct prepaid amounts and show them as an asset.

Understand Outstanding and Prepaid Expenses

Under the accrual system, you record an expense in the year it relates to, not in the year you pay cash. Cash paid during the year may cover more or less than that year's expense. Adjustments fix this at the year end.

Outstanding expense: the service is used in the year, but payment is still due. Example: December salary paid in January. The expense belongs to this year, so you add it. The unpaid amount is a liability, because you owe it.

Prepaid expense: you paid in this year for a benefit that falls in the next year. Example: insurance premium paid for 12 months where 3 months fall after the year end. That part is not this year's expense, so you remove it. The unexpired amount is an asset, because you will receive the benefit later.

In the final accounts, the expense line shows the amount that belongs to the year. Outstanding appears on the liabilities side of the Balance Sheet. Prepaid appears on the assets side. Next year, you reverse the opening balance so that the expense is not counted twice.

Key formulas to remember

Expense chargeable to P&L: Expense for the year = Cash paid + Closing outstanding − Opening outstanding − Closing prepaid + Opening prepaid; Use this when opening balances are given.
Outstanding expense entry: Expense A/c Dr. To Outstanding Expense A/c; Passed at year end. The outstanding account is a liability.
Prepaid expense entry: Prepaid Expense A/c Dr. To Expense A/c; Passed at year end. The prepaid account is an asset.
Final accounts treatment (outstanding): P&L: add to expense. Balance Sheet: show under current liabilities.; Applies when the item is given as an adjustment, not already in the trial balance.
Final accounts treatment (prepaid): P&L: deduct from expense. Balance Sheet: show under current assets.; Applies when the item is given as an adjustment, not already in the trial balance.
Opening balance reversal: Outstanding Expense A/c Dr. To Expense A/c; Expense A/c Dr. To Prepaid Expense A/c; Passed on the first day of next year. This stops double counting.

How to solve Outstanding and Prepaid Expenses questions

Use this method for any question on outstanding or prepaid expenses.

1Read the adjustment and mark the word: due, unpaid, owing or accrued means outstanding. In advance or relates to next year means prepaid.
2Check whether the trial balance figure is cash paid. It normally is.
3Work out the part of the amount that belongs to the current year.
4For outstanding, add the unpaid amount to the trial balance figure. For prepaid, subtract the advance part.
5Write the P&L line as the adjusted figure. You can show it as the trial balance amount plus or minus the adjustment.
6Show the adjustment in the Balance Sheet: outstanding as a liability, prepaid as an asset.
7If the question gives the previous year's balances, adjust for them too using the full formula.

Quickest way: Plus for owed, minus for advance

When to use it: Use this for MCQs that ask for the expense in the P&L or for the Balance Sheet amount.

Take the trial balance figure.
If outstanding, add it. If prepaid, subtract it.
The result is the P&L charge.
Put the adjustment itself in the Balance Sheet: outstanding on the liabilities side, prepaid on the assets side.
For monthly items, multiply the monthly amount by the months due or the months in advance.

Common mistakes in Outstanding and Prepaid Expenses

Subtracting outstanding expense from the expense in the P&L.
Students mix up outstanding with prepaid.
Fix: Outstanding means you still owe it, so the year's expense is higher. Add it.
Showing prepaid expense as a liability.
It sounds like something you owe.
Fix: You have already paid and will receive the benefit later, so it is an asset.
Adjusting an expense twice when it appears in the trial balance and in the adjustments.
Students fail to notice whether the adjustment is already reflected in the trial balance.
Fix: If an outstanding or prepaid balance appears in the trial balance, the expense is already adjusted, so only the Balance Sheet is affected. An item given under adjustments must be adjusted in the P&L as well as shown in the Balance Sheet.
Taking the wrong number of months.
Students count the months paid, not the months due or unexpired.
Fix: Write the period covered and the year end date, then count only the months after or before the year end as needed.
Ignoring opening balances from the previous year.
Students look only at the current year's adjustments.
Fix: Use the full formula: add opening prepaid and closing outstanding, deduct opening outstanding and closing prepaid.

Worked examples

Example 1

Rent paid during the year ended 31 March 2027 is ₹60,000. Rent for March 2027, ₹5,000, is still unpaid. Find the rent charged to the P&L account and state the Balance Sheet treatment.

Show the solution

The unpaid rent is an outstanding expense of ₹5,000.
Rent for the year = ₹60,000 + ₹5,000 = ₹65,000.
Journal entry: Rent A/c Dr. ₹5,000 To Outstanding Rent A/c ₹5,000.
Balance Sheet: show outstanding rent ₹5,000 as a current liability.

Answer: Rent charged to P&L is ₹65,000. Outstanding rent of ₹5,000 is a liability.

Example 2

Insurance premium paid on 1 October 2026 is ₹24,000 for 12 months. Accounts close on 31 March 2027. Find the insurance expense for the year and the prepaid amount.

Show the solution

Premium per month = ₹24,000 ÷ 12 = ₹2,000.
Months from 1 October 2026 to 31 March 2027 = 6. Expense for the year = 6 × ₹2,000 = ₹12,000.
Months after 31 March 2027 = 6. Prepaid = 6 × ₹2,000 = ₹12,000.
Check: ₹12,000 + ₹12,000 = ₹24,000, which is the amount paid.
Journal entry: Prepaid Insurance A/c Dr. ₹12,000 To Insurance A/c ₹12,000.
Balance Sheet: show prepaid insurance ₹12,000 as a current asset.

Answer: Insurance expense is ₹12,000 and prepaid insurance is ₹12,000, shown as an asset.

Exam tips

Look for keywords: due, unpaid, accrued mean add. In advance, unexpired mean subtract.
Check the final answer in the options. A wrong sign gives a number that often appears as a distractor, so verify direction.
For part-year payments, find the monthly amount first and count months carefully.
Remember where each goes: outstanding on the liabilities side, prepaid on the assets side.
No negative marking, so attempt every question. Eliminate options that go the wrong way.

Practice questions from Adjustment Entries and Rectification of Errors

Outstanding and Prepaid Expenses in other exams

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

ACCA Applied KnowledgePrepaid Expenses (Prepayments)

Outstanding and Prepaid Expenses: frequently asked questions

What is the difference between outstanding and prepaid expenses?

An outstanding expense is incurred but not yet paid, so it is a liability. A prepaid expense is paid in advance for a future period, so it is an asset. Outstanding raises the year's expense. Prepaid reduces it.

What is the journal entry for an outstanding expense?

Debit the expense account and credit the Outstanding Expense account. This records the expense of the year and the liability for the amount due.

How do I adjust prepaid expenses in final accounts?

Deduct the prepaid amount from the expense in the P&L account. Show the same amount on the assets side of the Balance Sheet as a prepaid expense.

Why do we reverse outstanding and prepaid entries next year?

The amount was already charged to the previous year. Reversing it on the first day of the new year ensures that the payment or benefit is not counted again as this year's expense.