In accrual accounting you may find it necessary to record certain transactions as prepaid expenses. You will then need to follow certain steps to properly record the prepaid expense in QuickBooks. A prepaid expense is a purchase you make for goods or services you will receive in the future or over a specified period of time. A good example of this would be insurance. Most insurance agencies require that you pay your premium in annual or semi-annual payments. In order to show more accurate financials that are not skewed by a large expense in one month it is necessary to use a prepaid expense. This will properly spread the expense over the entire coverage period that you are paying for. Another example of an expense you might want to consider prepaid expenses for is a quarterly utility bill. Watch this video which demonstrates how to properly handle recording prepaid expense in QuickBooks.
Set Up The Prepaid Expense As An Asset
You should set up a prepaid expense account as an asset account in QuickBooks. I would also consider making subaccounts of the parent account for the various prepaid expenses. As an example I might set up prepaid insurance as well as prepaid utilities. Separating prepaid items out into subaccounts should help keep things more organized and also make it easier to identify any mistakes with your accounting.
Record Your Payments
Any payments to vendors for goods or services that will be delivered in the future over a period of time should be booked to the prepaid asset expense account. Adding the accrual or policy period to the memo can be very useful. For example, if your insurance payment is for the period May 2013 - April 2014 it would be very helpful to add that to the memo.
Set Up Recurring Journal Entry
After you have properly recorded your prepaid expense by entering a bill or check I would immediately set up and memorize a recurring journal entry. Your journal entry should be as follows:
DR Expense account of your choosing
CR Prepaid expense asset account
When you originally recorded the prepaid expense bill or check the accounting that took place was:
DR Prepaid expense asset account
So your journal entry needs to move the money from the prepaid expense asset account to the expense account. In the example of insurance you would make this journal entry:
DR Insurance expense
CR Prepaid Insurance
I would then memorize the journal entry and set it up for recurring auto entry into QuickBooks as often as you would like. I would additionally give it a start date of the beginning month of the policy and set it up for automatic entry on a monthly basis with 11 remaining. By setting it up this way your monthly journal entry will happen automatically and your expense will be properly accrued. One thing you want to make sure is that your prepaid expense asset account has a balance of $0.00 at the end of the accrual period.
More Accurate Financial Reporting
The biggest benefit of using prepaid expenses is more accurate financial reporting. In the example of insurance if your annual premium for insurance was $10,000 and you did not use a prepaid expense account you would have a large expense taken in one month. This would make a financial analysis of your business difficult. If you are comparing financials on a month to month basis or every four weeks then this large expense would be throwing your comparisons off. By using prepaid expenses you will make your financial reports more consistent and easier to compare from period to period.
Using prepaid expenses is not difficult and has some major advantages. Don't make the mistake of setting it up as an expense account because you may double enter your expenses. Also, be sure to make sure that your prepaid expenses have a balance of $0.00 at the end the expenses life cycle.