What is a prepayment?
- By Book Keeping Pros
- Sources checked 16 Oct 2026
Definition
A prepayment is an amount a business pays before it receives the goods or services it covers, such as a year's insurance or software subscription paid in advance. Under accrual accounting, the part not yet used is recorded as an asset, often called a prepaid expense, and moved to expenses over the period the payment covers.
A prepayment matters when one payment covers more than one accounting period. If a business pays for 12 months of a service at once and records the whole amount as an expense straight away, the month of payment looks costly and the months after it look cheaper than they really are. Recording the unused part as a prepayment keeps each period's profit and loss statement closer to the cost that belongs to it.
In the books, the payment goes to a prepayment account on the balance sheet, or is split between that account and the expense for the current period. At the end of each later period, a journal entry moves the part now used up from the prepayment account to the expense account, until nothing is left. A simple schedule listing each prepayment, the period it covers and the amount still unused makes those entries easier to check.
Money a customer pays the business in advance is the other side of this arrangement, not a prepayment of the business's own. Whether a business uses accrual accounting at all, which payments are worth recording as prepayments and how a customer's advance payment is recorded are questions for your accountant.
In Australia
The Australian Charities and Not-for-profits Commission (ACNC) works through a prepayment in its guidance on cash and accrual accounting, which is written for charities preparing their annual financial reports for the ACNC. In its example, a charity that has been paying a website provider monthly pays for a 12-month subscription in advance on 1 December, and its reporting period runs from 1 January to 31 December. Under the accrual method, only the part of the payment relating to December is recorded as that year's expense, and the remaining months sit on the balance sheet as an asset, in a prepayment account. Under the cash method, the whole payment counts as an expense when it is paid, so the year's subscription expense comes out higher. In the ACNC's view, the accrual figure reflects the year's subscription cost more closely, because accrual accounting looks at when an expense is incurred rather than when it is paid.
The same guidance says medium and large charities must use accrual accounting in their financial reports, while small charities can choose cash or accrual accounting unless their governing document, a government department or agency, or a funding body requires accrual.
Worked example
| Entry | Account | Debit (AUD) | Credit (AUD) |
|---|---|---|---|
| Pay the year's premium | Prepaid insurance | 2,400.00 | |
| Bank | 2,400.00 | ||
| End of the first month | Insurance expense | 200.00 | |
| Prepaid insurance | 200.00 |
Illustrative example only: these rows show the method and are not sourced data.
Common mistakes
- Recording a large payment that covers the next 12 months as an expense in the month it was paid, without asking your accountant whether it should be recorded as a prepayment.
- Setting up a prepayment and then forgetting the month-end entries, so the asset stays at its full amount and later periods show no expense for it.
- Treating money a customer has paid you in advance as a prepayment of your own; ask your accountant how to record it.
- Not checking the prepayment balance against what is still unused when the balance sheet accounts are reviewed at the end of a period.
Related terms
Related service
Small business bookkeeping
Your books kept current, every month.
Sources
- Cash and accrual accounting
Australian Charities and Not-for-profits Commission. Current at 16 October 2026, released 3 August 2023. Checked 16 October 2026.
© Commonwealth of Australia 2018 Licence: CC BY 4.0.