How-to · Adjusting entries
How to record a prepaid expense
When you pay in advance for something you will use over several months, record the payment as an asset called Prepaid Expenses. Then, each month, move that month's share to the expense account with a journal entry until the prepaid balance is zero.
How-to guides / Prepaid expense
The accounting behind it
Under accrual accounting an expense belongs to the period that benefits from it. A year of insurance paid in January benefits all twelve months, so charging it all to January makes January look terrible and the rest of the year look too good.
The payment buys a right to future service, which is an asset. A prepaid expense sits in current assets on the balance sheet and shrinks as you use it.
Small prepayments aren't worth the effort. Many businesses set a threshold (say $500 or $1,000) and expense anything below it straight away.
| Account | Debit | Credit |
|---|---|---|
| Prepaid Expenses (asset) | Amount paid | |
| Bank | Amount paid |
| Account | Debit | Credit |
|---|---|---|
| Expense (insurance, rent, software) | Monthly share | |
| Prepaid Expenses | Monthly share |
Worked example: $2,400 of annual insurance
On January 1 you pay $2,400.00 for a 12-month liability policy. That is $200.00 a month. After the March entry, $600.00 has been expensed and $1,800.00 is still prepaid.
| Account | Debit | Credit |
|---|---|---|
| Prepaid Insurance | $2,400.00 | |
| Checking | $2,400.00 |
| Account | Debit | Credit |
|---|---|---|
| Insurance | $200.00 | |
| Prepaid Insurance | $200.00 |
Common mistakes
- Expensing the whole payment when it is made.
- Setting up the prepaid asset and then forgetting the monthly entries, so the asset never goes down.
- Continuing the monthly entry after the prepaid balance reaches zero.
- Prepaying for more than a year and treating it all as current.
In the US and in Canada
United States
For tax, IRS Publication 538 describes the 12-month rule: you don't have to capitalize amounts paid for benefits that don't extend beyond the earlier of 12 months after the benefit begins or the end of the tax year after the year of payment. A one-year policy paid on July 1 can be deducted in full; a three-year policy cannot. Your books can still spread it monthly.
Canada
Canadian income tax rules generally let you deduct a prepaid expense only in the year it relates to (subsection 18(9) of the Income Tax Act), which matches the monthly bookkeeping. If you paid GST/HST on the prepayment, the input tax credit is claimed when the tax is paid or payable, not spread.
In AcboBooks
AcboBooks 0.2.1 has no prepaid schedule screen; you pay into an asset account and set the monthly journal entry to repeat.
AcboBooks 0.2.1 has no separate screen for this, so it is done with a journal entry.
- Create the asset account. In Company → Chart of Accounts click + New Account, choose Account type Other Current Asset and name it, for example, Prepaid Insurance.
- Record the payment. Pay with Banking → Write Checks (choose Prepaid Insurance on the line) or enter the bill in Vendors → Enter Bill with that account.
- Make the first monthly entry. Go to Activities → Make Journal Entry. Debit the expense account and credit Prepaid Insurance for one month. Tick Adjusting entry if you track adjustments, then click Save & Post.
- Make it repeat. Before clearing the form, click Make recurring and name it. Then in Activities → Recurring click Schedule, choose Monthly, set the Next date, tick Automatically enter when due (on company open) and click Save Schedule.
- Stop it. When the prepaid balance reaches zero, delete the template in Activities → Recurring.
Menu names are from AcboBooks 0.2.1. Not using it yet? Try it free for 15 days, with the sample company to practise on.
Questions
Is a prepaid expense an asset?
Yes, a current asset. It becomes an expense as the months pass.
Can I just expense it when I pay?
For small amounts, many businesses do. For large ones, spreading it gives a truer monthly profit. US tax may still allow the full deduction under the 12-month rule.
What are common prepaid expenses?
Insurance, rent paid in advance, annual software subscriptions, maintenance contracts and retainers paid to advisers.
Related how-to guides
Terms used here
Sources
Updated October 25, 2026. General bookkeeping information, not tax, legal or accounting advice. Rules differ by state and province and change over time; check with the IRS, the CRA or your accountant for your own situation.
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