Unexpired expenses, also known as prepaid expenses, are bills your business pays in advance. Suppose you pay your rent for the year on January 1 and also buy a full year of general liability insurance. At the end of January, your landlord and your insurer still owe you 11 months of services. You report such unexpired expenses in your bookkeeping journal differently from regular expenditures.
For example, say that on January 1, you pay $12,000 in insurance for the next 12 months. When you make the unexpired insurance journal entry in your ledger that day, you list $12,000 as an asset because you haven't used it yet. At the end of the month, you transfer $1,000 out of assets to an expense account because you've used up the first month's insurance.
Why Unexpired Expenses Are Different
Unexpired expenses are treated differently from regular purchases because you don't see an immediate reward for spending the money. If you pay $2,000 for computer repairs, the transaction expires once the repairs are complete and money changes hands. If you pay $15,000 for 12 months of insurance, from an accounting perspective, the expense doesn't expire for a year.
Although any type of prepaid service can generate unexpired expenses, the big categories in business are insurance and rent. When you make a prepaid rent or unexpired insurance journal entry, you report the money as an asset, entering it in a prepaid insurance account in the books.
Prepaid Insurance: Adjusting the Entry
Suppose you buy $1,500 in errors and omissions insurance that is good for the next 12 months. You enter the payment in the asset account for prepaid insurance and make another entry for $1,500 in your cash account.
One month later, you've used up a month of coverage, so that part of the prepayment is now an expired expense. You reduce the prepaid insurance account by $125 and make a journal entry for $125 in expenses. You don't have to adjust cash, as you're not spending any more money.
You do the same thing with an unexpired rent adjusting entry. If you prepay your rent for the year, you record the transaction in prepaid rent and in cash in your accounting journal. Each month, you shift over 1/12 of the initial payment from prepaid rent to rent expense.
Unexpired Insurance in Financial Statements
If your prepaid expenses expire before you prepare your financial statements for the quarter or the year, they won't affect the statements. Once unexpired expenses expire, they're just regular expenses. If you still have unexpired expenses on the book when you make out the statement, you have to treat them accordingly.
The three big financial statements are the income statement, the cash flow statement and the balance sheet.
- The income statement shows how much money you've earned and spent in the period. It includes money you've earned but haven't been paid and bills you owe but haven't paid yet.
- The cash flow statement reports actual money spent or received. Where the income statement shows how profitable you are, the cash flow statement shows whether you have enough cash on hand to stay afloat.
The balance sheet is an equation with assets on one side and liabilities and owners' equity on the other. Subtract liabilities from assets, and you get equity
the amount the owners could divide if the company paid all its debts and liquidated.
Unexpired expenses don't affect cash flow because you've already paid for them. You report the expired portion of the prepayment on the income statement as an expense. You report the unexpired portion as an asset on the balance sheet.