Definition. A prepayment is a cost a business has paid in advance for goods or services it will receive in a later accounting period. The cost is held on the balance sheet and charged to profit and loss in the period it relates to.
Where it sits in the accounts. A prepayment is a current asset, usually within “Prepayments and accrued income” under debtors. It is a debit balance.
A company with a 31 December year end pays £2,400 on 1 October for 12 months of business insurance. The full £2,400 was posted to insurance expense when paid, but by 31 December only 3 months (£600) have been used.
The profit and loss account shows insurance of £600 for the year, and £1,800 is carried forward as a prepayment. It is charged to the next year as the cover is used.
An asset. The business has paid for something it has not yet received.
A prepayment is paid before the cost is used (an asset). An accrual is a cost used but not yet invoiced or paid (a liability).
Annual insurance, software subscriptions, rent paid quarterly in advance and event deposits.
Related terms: Deferred income · Accruals basis · Current asset