Academy/Financial Statements for Non-Accountants
Prepaid expenses
Why a payment your association already made can still show up as an asset, not an expense.
A prepaid expense is money your association has already paid out for something it has not fully used yet, like a full year of insurance paid in one check in January. Because the benefit stretches into future months, accounting rules record it as an asset on the balance sheet, not as an expense, until that future period arrives.
What counts as a prepaid expense
The classic example on an association's books is the annual insurance premium. Say your master policy renews every January and the full year is billed and paid in one lump sum. That payment covers twelve months of coverage, but only one month has actually happened by the time the check clears. The other eleven months are a benefit the association is still owed.
"A prepaid expense is an expenditure that is paid for in one accounting period, but for which the underlying asset will not be entirely consumed until a future period."
Source: Prepaid expense definition, AccountingTools
Other common examples include a prepaid maintenance contract or a software subscription billed annually. The test is always the same: has the association paid for something it has not yet fully used?
Why it sits on the balance sheet as an asset
It can feel wrong to call a payment an asset instead of an expense. But an asset is defined by future benefit, not by whether cash already left the account. The remaining months of paid-up insurance are a real, measurable benefit the association still holds, so they belong with everything else the association owns.
That is why you find the prepaid expense on the balance sheet, the report that captures what the association owns and owes as of one date, rather than on the income statement, which covers a stretch of time.
"A balance sheet lays out the ending balances in a company's asset, liability, and equity accounts as of the date stated on the report."
Source: The balance sheet, AccountingTools
Each month, a small slice of that prepaid asset converts into an actual insurance expense on the income statement, until, by December, the whole year has been used up and the prepaid balance is back to zero.
What to look for in your board package
Scan the asset section of the balance sheet for a line labeled "prepaid expenses" or "prepaid insurance." If the number barely moves month to month, ask why. If it drops to zero all at once instead of shrinking steadily, ask whether it was actually being tracked monthly or just written off at renewal.
Prepaid expenses are the mirror image of an accrued expense, a cost the association owes before a bill even exists. Knowing which is which helps you read the rest of the balance sheet with confidence.
Check yourself
Answer before you read the explanation, recalling it is what makes it stick.
Your association pays a $12,000 annual insurance premium every January. In February, how should that payment appear in the board package?
A board member asks why the balance sheet shows an asset called "prepaid expenses" when the association has no cash left over. What is the best answer?
The association pays its landscaping contractor $2,000 for work completed last month, but the invoice has not been entered yet. What is that $2,000?
Sources
- Prepaid expense definition, AccountingTools
- The balance sheet, AccountingTools
- Statement of Financial Accounting Concepts No. 6, Elements of Financial Statements, Financial Accounting Standards Board
Financial Statements for Non-Accountants
Next, see how a prepaid expense's opposite number, the accrued expense, shows up on the same balance sheet.
Whether your association's own board-facing statements are prepared on a cash or accrual basis varies by association, and that choice determines whether prepaid expenses appear on your balance sheet at all. Confirm with your CPA or manager which basis your statements use.