Some expenses must be paid prior to the business using the paid-for item. One common prepaid expense is insurance. Most insurance companies require you to pay for insurance 6 to 12 months in advance. Another common prepaid expense is rent. Some retail stores are expected to pay rent quarterly rather than monthly.

The prepaid expense account is shown in the asset section of the balance sheet. Because this prepaid expense is a short-term asset that is used in less than 12 months, you would place it before the land account. Give it a number of 1250 to make it appear after the inventory account on the balance sheet. The total for assets is reduced as the insurance expense is allocated monthly through the year.

The prepaid expense account would appear as follows in the general ledger.

1250 Prepaid Expenses

At the end of the month, you would record the actual expenses by reducing the amount in the prepaid expense account and recording the expense that should be allocated to that month. For example, at the end of January you would make this adjustment to the chart of accounts.

After the adjustment at the end of the month, the prepaid expense account in the general ledger would look like the following.

1250 Prepaid Expenses

Making this adjustment matches the expenses for rent and insurance that should be allocated to the costs of operating the business in January. If you were using the cash-basis accounting method, you would not have a prepaid expense account, and the month of January would have large expenses that would offset any profit.

You can develop a schedule similar to the one you used for depreciation to keep track of prepaid expenses. This kind of schedule is a quick and easy way to know what needs to be recorded each month; it helps you remember to do the adjustments and reminds you when another annual or quarterly payment is due.