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Prepaid Expenses and Unearned Revenue

There are two new accounts included in the chart of accounts on the previous page:

• prepaid insurance (a prepaid expense) and
• unearned revenue.

Prepaid Expenses

Prepaid expenses (also known as deferred expenses) are payments of an expense in advance. We are using the accrual basis of accounting and recognize expenses when they are incurred, not necessarily when they are paid. When we prepay expenses, such as rent and insurance, they are initially recorded as assets. When the amount prepaid is used up, we will move the portion used from the asset account into an expense account. This process is explained in Lesson 3. The more common prepaid expenses include

• prepaid rent and
• prepaid insurance.

Rent and insurance are items that both individuals and businesses normally prepay.

We record rent as follows:

1. The current month’s rent is debited to rent expense, regardless of when the rent was paid.
2. If you prepay two or more months' rent in advance, we will debit an asset account (prepaid rent).

Prepayment of insurance is debited to an asset account (prepaid insurance).

Unearned Revenue

Unearned revenue (also known as deferred revenue) occurs when we receive payments before we complete the service (i.e., earned the revenue). We are using the accrual basis of accounting and recognize revenues when they are earned, not necessarily when the payment is received. When customers prepay revenues, they are initially recorded as liabilities. When the service is provided, the amount prepaid is earned, and we will move the portion earned from the liability account into a revenue account. This process is explained in Lesson 3.