A prepaid expense is an accounting term referring to a payment made for goods or services that will be received or used in the future. These payments are considered assets on a company's balance sheet until they are utilized or consumed, at which point they are expensed on the income statement. Common examples of prepaid expenses include rent, insurance, and subscriptions.

For instance, if a company pays an annual insurance premium upfront, the payment is initially recorded as a prepaid expense. Each month, a portion of this prepaid amount is expensed, reflecting the cost of insurance coverage for that period. This process is called amortization and ensures that the expense is matched with the period in which the benefit is received, adhering to the matching principle in accounting.

Prepaid expenses are important because they represent future economic benefits to the company. Properly managing and recording these expenses helps ensure accurate financial reporting and provides a clearer picture of the company’s financial health. Failure to account for prepaid expenses correctly can lead to misstated financial statements, affecting business decisions and potentially leading to regulatory issues.

In summary, prepaid expenses are advance payments for future benefits that are initially recorded as assets and systematically expensed over the periods they benefit.