Whether you are a student studying accounting and finance in a university or college or have just developed an interest in managing your business accounts, it is important to understand the meaning and difference between prepaid expenses and accrued expenses
It is possible to get confused easily on the difference between prepaid expense vs accrued expense. Therefore, there is a need to highlight the difference comprehensively, in order to avoid any confusion which may arise when preparing your company's financial statements.
What Is The Difference Between Prepaid Expenses And Accrued Expenses?
Prepaid and accrued expenses are mirror image of each other. While Prepaid Expense is regarded as an asset, Accrued Expense is viewed as a liability in the financial statement. Check out our comprehensive articles on the meaning and types of assets, types of liabilities in accounting.
Before we discuss the difference between accrued expenses and prepaid expenses, we must first explain their meaning and which class of account they belong to.
What Is a Prepaid Expense?
A prepaid expense is an accounting term which means payments in advance for goods or services to be received in the future. Initially, they are recorded as assets, but their value is expensed as time goes by in the income statement (profit and loss account) as the business use the product or service that was paid for. Contrary to the regular expenses, the business will receive something valuable from the prepaid expense in the course of numerous accounting periods. You can check out our full article on prepaid expenses and its accounting entries.
What Are Examples of Prepaid Expenses?
An example of prepaid expense is payment of insurance premium. Although insurance payment is an expense in the income statement, however the main reason for engaging an insurance coverage is to receive benefits from this expense in the future.
These expenses are recorded in the current asset of the balance sheet. Therefore when the insurance premium is fully paid at the beginning of the insurance period, the prepaid expense account for insurance is debited since you are yet to fully enjoy the services and the cash account is credited in the balance sheet since there would be decrease in cash with the amount as a result of payment for the insurance premium.
Be that as it may, at the end of every periodic Balance Sheet, it is essential to credit the prepaid expense account for insurance and debit the insurance expense account since some parts of the expenses have already been used.
Other examples include advance payment of rent, supply orders in stock, tax paid in advance by corporations before payment of the real tax liability.
What Is Accrued Expense?
An accrued expense, also called accrued liabilities, is an expense that is recognized on the books before it has been fully paid for. In other words, they are payments for goods and services which have been enjoyed by the buyer when they are yet to pay for them. This is different from instalment payments. Since accrued expenses represent a company's obligation to make future payments for goods or services, they are shown on the current liabilities side of a company's balance sheet.
What Are Examples of Accrued Expenses?
An example of an accrued expense is when a company buys goods from a merchant but has not yet paid for the product. Other examples include interest on loans, warranties on products or services received, and taxes; all of them have been incurred, but no invoices have been received nor payments made.
Prepaid Expenses Versus Accrued Expenses: The Key Difference
The key difference between prepaid expenses and accrued expenses is that prepaid expenses are payments made in advance for goods and services that are expected to be used in the future and are recognized as current assets in the company's balance sheet while accrued expenses are costs that a company has already incurred during business activities but not yet paid for by the end of the accounting period and are recognized as a liabilities in the balance sheet.
Frequently Asked Questions
Question: What is the authentic difference between accrued and prepaid expenses?
Answer: As the name implies, prepaid expenses are the payments made in advance by a business for goods and services not yet used. On the other hand, accrued expenses in business are payments for already used goods and services which are added to the liabilities side of the balance sheet.
Question: What type of expenses are prepaid expenses?
Answer: Prepaid expenses for a business include the following
- Purchase Order Advance
- Quarterly Estimated Taxes
Question: What type of expenses are termed as accrued expenses?
Answer: Accrued expenses include the following:
- Raw material and supplies