Prepaid Expenses
Prepaid expenses are assets that arise because an organization has paid for services that it will receive in the future, with the future being defined as a time past the fiscal year-end. The most common example of a prepaid expense is an insurance premium. Let us say that a government has a June 30 fiscal year-end. It pays its general liability insurance premium (assume it is $1,000) on January 1, for the next full calendar year. By June 30, it has used up six months of insurance, but still has another six months of insurance to which it is entitled. The organization would allocate the $1,000 of insurance premium over the 12-month calendar year period. On June 30, it would record a reduction of its insurance expense and record a prepaid insurance expense asset of $500 ($1,000 times 6/12). Note that this organization uses up this prepaid asset during the period from July 1 through December 31. If the organization issued its 6-month financial statements on December 31, it would reduce the entire prepaid asset to zero and record the corresponding $500 as insurance expense, which makes sense because, since the insurance works on a calendar year basis, on December 31, the organization has not prepaid any of its insurance. Assuming in this example that the insurance premiums stay the same every year, the government would have recorded $1,000 of insurance expense in its fiscal year ($500 recognized as a result of the premium payment and $500 recognized when the prepaid expense asset is used up).
While prepaid insurance is the most common and easily understood example of a prepaid expense, there can be many others. Rental payments on facilities or equipment are another example. Some judgment should be used by governments in determining what should be recorded as prepaid expenses. For example,
a motor vehicle registration fee is usually paid annually in advance. If the government only owns a few motor vehicles, it is probably not worth the administrative effort to calculate and record this type of prepaid expense, particularly when registrations expire throughout the year.
Taken From : Governmental Accounting Made Easy