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Balance sheet prepaid insurance11/22/2023 ![]() Presentation on the balance sheet Current asset vs. Under the cash basis an organization would immediately record the full amount of the purchase of a good or service to the income statement as soon as the cash is paid. On the other hand, an entity using the cash basis of accounting as opposed to the accrual basis expenses payments when incurred and does not attempt to match the cost of a good or service to the period or periods over which it is used. The advance purchase is recognized as a prepaid asset on the balance sheet. Prior to consumption of the good or service, the entity has an asset because they exchanged cash for the right to a good or service at some time in the future. Therefore under the accrual accounting model an entity only recognizes an expense on the income statement once the good or service purchased has been delivered or used. Accrual accounting adheres to the matching principle which requires recognizing revenue and expenses in the period they occur. Entities following US GAAP and hence issuing GAAP-compliant financial statements are required to use accrual accounting. It is important to consider what basis of accounting an organization is operating under when assessing how to account for prepaid expenses. Accounting for prepaid expenses Accrual basis vs. As a rule of thumb, prepaid expenses have been paid but are yet to be realized whereas accrued expenses are incurred but yet to be paid. As a result, a payable or accrued expense is recognized as a liability. Accrued expenses, such as accrued rent, are the result of receiving a service or goods before payment is made. ![]() It is also important not to confuse a prepaid expense with an accrued expense. To note, if one party is recognizing a prepaid asset on their balance sheet, then the party providing the service or goods will recognize unearned revenue, a liability, on their balance sheet until they fulfill the contractual obligation of providing the service or goods for which they received payment. Prepaid expenses result from one party paying in advance for a service yet to be performed or an asset yet to be delivered. ![]() A “prepaid asset” is the result of a prepaid expense being recorded on the balance sheet. Prepaid expenses, or Prepaid Assets as they are commonly referred to in general accounting, are recognized on the balance sheet as an asset. In this article, we will delve further into how to appropriately account for prepaid expenses and their impact on the financial statements as well as decision-making. Organizations recognize prepaid expenses for a myriad of reasons but generally, they occur when dealing with contracts, service agreements, and assets that allow the receiving party to pay in advance, hence the name, prepaid expense. Accounting for prepaid expenditures and ensuring they are properly recognized on your financial statements is a critical piece of financial reporting.
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