Revenue recognition

How to automate prepaid expenses

FINANCE SPECIALIST

Marjorie Stern Jackson

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Automating prepaid expenses, the costs a business pays upfront for future goods or services, not only saves time but also enhances accuracy and ensures compliance with accounting standards. Leveraging a prepayments automation tool such as ScaleXP, which seamlessly integrates with major accounting platforms, can significantly streamline your financial operations.

What are prepaid expenses?

Prepayments are upfront costs for services not yet received.  Payments for services not yet received are recorded as assets on the balance sheet, representing an economic benefit contractually receivable in the future.  This complies with the IFRS and GAAP principals of matching reporting cost and revenue to the timing of the services provided or received.

As the goods or services are consumed or time passes, prepaid expenses are gradually recognised as expenses on the income statement, matching the expense with the period in which the benefit is received.

Common examples of prepayments include:

  • Rent: rent is often paid quarterly in advance, leading to at least two months of prepaid expenses;
  • Insurance premiums: insurance is usually billed in advance of the period of insurance coverage;
  • Advertising contracts: advertising campaign costs are often arranged and paid in advance of the activities taking place;
  • Subscriptions: many service subscriptions are billed in advance for periods longer than the standard one month accounting period.

Accounting for prepaid expenses

When a prepayment is initially recorded, it is categorised as a current asset on the balance sheet. This reflects the expectation that the benefit will be realised in the future. As the benefit is consumed or the service period elapses, the prepaid expense is gradually expensed and moved from the asset side to the expense side of the income statement.

For example, if a company pays $12,000 upfront for a one-year insurance policy, it will initially record the payment as a prepaid insurance asset. Each month, $1,000 will be expensed, reducing the prepaid insurance asset by the same amount until the policy is fully expensed at the end of the year.

Other names for prepaid expenses

Don’t be confused by the many names referring to expenses paid in advance and recognised over time.  Regardless of the terminology, these all reflect the underlying concept of payments made in advance for benefits to be received in future periods.

  • Prepayments: particularly in certain countries like the UK, this single word is often used instead of either prepaid expenses or prepaid costs;
  • Deferred expenses: this emphasises the fact that some or all of the expense from the invoice is delayed, or “deferred”, in terms of its recognition on the P&L;
  • Prepaid costs: Another way of saying expenses paid in advance;
  • Advance payments: This makes it even more clear that the payment is occuring in advance of the service being delivered;
  • Prepaid charges: Another synonym for prepaid costs, this one is often used in the context of payments for utiltiies or services;
  • Unexpired costs:  This reflects that the costs have not yet “expired” and will be recognised later, over time;
  • Prepaid assets: This refers to the balance sheet element of the prepayment, focusing on the amount not yet recognised in the P&L;
  • Prepaid outlays: This emphasies the cash flow element of prepaid expenses in that the cash outlay is in advance of the economic benefit being achieved.

Automating prepaid expense recognition

Prepaid expenses need to be accurately allocated to the relevant accounting periods.

Traditionally, this process involves labour-intensive spreadsheets and manual calculations, leading to errors and inefficiencies.

Automating this process offers several key benefits:

  • Time savings / faster month end closing: Automation eliminates the need for manual data entry and complex spreadsheet maintenance, allowing accounting teams to focus on more strategic tasks. Automated systems can close the month up to three days faster by processing and allocating expenses in real-time.

  • Improved accuracy: Automation reduces the risk of human error, ensuring correct allocation of costs and compliance with accounting standards.

  • Compliance: Automated systems ensure that all expense recognitions are in line with IFRS and GAAP, making audits straightforward and stress-free.

How ScaleXP automates prepaid expenses

ScaleXP is a great way to automate prepayments as it includes the following features:

  • Seamless Integration with your accounting system: ScaleXP integrates with major accounting systems such as Xero, QuickBooks and Zoho, importing bills and invoices directly.

  • Advanced natural language algorithms: ScaleXP’s smart technology is able to read dates directly from supplier bills, saving hours of time in setting up accounting prepayment assets.

  • Real-time processing and updates: Daily processing ensures prepaid expenses are always current.

  • Draft journal preparation: Streamlines the finalisation of accounts with direct links to your accounting system.

Getting started with ScaleXP

Ready to automate your prepaid expenses?  Arrange a free trial or demo here.