UNDERSTANDING ACCOUNTING TALK 26 Expenses vs Accounts Payable (Liabilities) & Prepaid Expenses (Assets)

Not all Expenses incurred during a period are paid within the same period. Some Expenses can be paid in a succeeding period. Some Expenses can be prepaid; for example, insurance is usually paid in advance on an annual basis.

When payment of an Expense is paid in a succeeding period, it is recognized within the period in the Income Statement for the period. A corresponding amount is added to Accounts Payable. If there are no penalties attached to the postponement of payment of Expenses, it is a good management financial strategy to postpone –thus conserving Cash and extending the capacity of the working capital of the business.

When an Expense is paid in advance (e.g., annual insurance premium), it is recognized within the period in the Income Statement for the period and added to Assets as a Prepaid Expense. In this case, while Cash is decreased by the payment, there is no change in total Assets because there is a corresponding increase in another Asset Account (Prepaid Expenses).