In accrual accounting, payments are recorded when the financial event occurs, not when the cash actually changes hands. For example, payment for an expense is registered in the period in which the payment occurs, no matter when the service or goods are actually received. When using the cash accounting system, you would record the payment as soon as it’s made. This affects when the expense/income is recorded in the financial records of a business. The two types of accounting systems handle payments differently. A prepaid expense is a type of asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Registering prepaymentsĭepending on your business, you might find that you regularly work with prepayments. This way, the costs involved will be charged to the correct accounting period. This amount will be subtracted from the balance sheet and added to the costs of the P&L.
If they have not been received by the end of the financial year, then the amount prepaid will appear in the balance sheet as prepayments and not as costs in the profit and loss account. Insurance is a regular example of an expense that requires prepayment due to the nature of the service. In this case, the payment is known as a prepayment.
However, some types of goods or services require up-front payment in full before the goods or services are provided. An invoice is then sent for payment, meaning the payment occurs after the order is completed to ensure the goods are sent or are as expected. In the traditional sales process, goods or services are ordered and fulfilled. A deposit is also generally a part of the total amount, while a prepayment usually covers the full cost. Ī prepayment is not dissimilar to a deposit but generally falls under a more set time period for fulfilment of the goods or services purchased.
Any payment made in advance can be considered a prepayment.Ĭreate, send and track your invoices for free with SumUp Invoices. Prepayments are amounts paid for by a business in advance of the goods or services being received later on.