Prepaid expenses in a client's year-end figures
How to split a client's advance payments, such as insurance, rent and licences, between the year's expense and a prepayment asset at year end.
By Achekam · · 4 min read · For Accountants & audit firms in South Africa, Nigeria, Kenya
A client pays its annual insurance premium in the fourth month of its financial year. The full premium goes to the insurance expense account, and at year end the trial balance shows a whole year's cover charged to a year that only benefited from part of it. The rest of the cover belongs to next year.
Small clients do this constantly, and for good reason: their bookkeeping follows the bank. Insurance, rent paid in advance, software licences, professional memberships, vehicle licences and advertising contracts are all paid up front and expensed when paid. At year end, the firm's job is to carve out the part that has not yet been used.
Paid now, benefit later
Investopedia defines a prepaid expense as a payment made in advance for goods or services the company will receive in the future, recorded as an asset on the balance sheet until the benefit is realised. It also states that under generally accepted accounting principles, expenses should be recorded in the same period as the benefit generated from the related asset.
ACCA's year-end adjustments article describes the presentation: expenses paid in advance are shown as current assets (prepayments), and the profit or loss charge is adjusted accordingly. Investopedia likewise notes that prepaid expenses are usually listed as current assets.
The principle is the mirror image of an accrual. With an accrual, the benefit came first and payment later. With a prepayment, payment came first and the benefit runs on past year end.
Working out the unexpired part
The question for each advance payment is: how much of the period paid for falls after the year end?
The approach is simple:
- Identify the period the payment covers, from the invoice, policy schedule or contract.
- Count how much of that period falls after the client's year end.
- The prepayment is that share of the payment.
Investopedia's explanation of prepaid expenses illustrates how the asset is used up: a prepaid expense becomes an expense over time through monthly adjusting entries as the service is used, for example moving one-twelfth of a year's prepaid insurance to expense each month. A client that posts those monthly entries will already have the right prepayment at year end. Most small clients do not, so the firm calculates it once.
Days or months? For most clients, months are accurate enough. Where a payment is large and its period starts or ends mid-month, days give a more precise split; choose one approach for the client and use it consistently.
Annual policies spanning year end
A worked example in words. A client with a December year end renews its business insurance at the start of each April. The annual premium covers April to the following March. At year end, three months of cover remain: January to March. The prepayment is three-twelfths of the premium; the other nine-twelfths are the year's expense.
But last year's premium matters too. If last year's policy also ran April to March, its last three months fell in this year. So this year's insurance expense is the unexpired portion of last year's premium, released as the opening prepayment, plus the used portion of this year's premium. If the firm calculates only the closing prepayment and forgets to release the opening one, the year's expense is understated.
Other common items:
- Rent paid in advance, often a month or a quarter at a time; the prepayment is usually small but regular.
- Annual software subscriptions renewed at different times of the year.
- Membership and registration fees for professional bodies or trade associations.
- Advertising contracts paid before the campaign runs.
- Deposits paid to suppliers for goods not yet delivered, which behave like prepayments until the goods arrive.
Set a sensible floor: chasing tiny prepayments costs more than it is worth. The floor should be recorded and applied consistently.
Presenting and posting the adjustment
The prepayment sits in current assets, usually within trade and other receivables or on its own line where it is significant. It should not be netted against payables or accruals.
In Achekam's Studio, staff can post the year-end adjusting entry that moves the unexpired part from expense to prepayments. Reviewers can see what was posted, and an entry that turns out wrong is reversed with a record of who did it and why rather than deleted.
Where the client's books are maintained through Achekam's Financial Intake, journals proposed from documents, bank lines or adjustments are only candidates, and a person approves and posts each one; AI is refused both steps. When a large annual invoice comes through, that review point is a natural moment for the person approving it to code the unexpired portion to prepayments straight away, so less needs fixing at year end.
A schedule the reviewer can follow
Keep a short prepayments schedule on the file for each client, showing:
| Item | Period covered | Amount paid | Part after year end | Prepayment |
|---|---|---|---|---|
| Insurance | Policy dates | From the invoice | Months remaining | Calculated |
| Software licence | Licence dates | From the invoice | Months remaining | Calculated |
Add a line for each opening prepayment released, so the reviewer can see both ends of the year. Carry the schedule forward each year: most of the same items will recur.
The opposite adjustment, for costs incurred but not yet paid, is covered in finding and booking accrued expenses, and adjusting entries at year end brings the year-end entries together. Ask each client for its insurance schedule and its list of annual subscriptions with the year-end pack; between them, they cover most of the prepayments.
General guidance only, not advice on your own circumstances. Tax and payroll rules change: check the current position with the authority or your adviser.
