When should you record the expense when you’ve paid for a whole year up front?
The problem with booking an entire year’s expense when paid is that you are in violation of one of the basic principle of accounting called “Matching”. This principle says that an expense should be recorded in the period in which it was incurred to properly match it up with that period’s revenue. This way our financial statements more accurately reflect the financial position of the company.
The mistake that most people make is that they book the entire year’s premium to Insurance Expense when they pay it. This doesn’t really accurately reflect what is happening though. What is really happening is that we are pre-paying for an expense. We are paying now for something that we are going to get a benefit for each and every month for the next 12 months. Specifically we will be covered. So the more accurate accounting on this is to show the expense evenly over the 12 months and the way to do this is to record it as an asset. A prepaid expense is an asset because we’ve paid for something that we haven’t received the benefit for just yet. Then we record a journal entry each month to record the expense and reduce the pre-paid expense. This can be automated so that you don’t have to worry about it every month – once you set it up, QuickBooks will do the work for you.
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