A Prepaid Expense is an accrual basis of accounting category of an asset where cash is paid to a vendor for use in the future. The principle insists that an expense should be recognized in the same period its benefit is derived.
Any vendor invoices or contracts paid exceeding a threshold of $10,000 should be reclassed to a prepaid expense account Prepaid expenses are future expenses that have been paid in advance. As the item purchased is used, the expense is recognized.
At month end, Finance reviews all expenditures >$10,000 to determine if a prepayment needs to be recognized. If it does, Finance will raise a prepayment on behalf of the affected department. The prepayment will be recognized within 12201 - Prepaid Expenses and amortized over the period during which the expense will apply. Finance will also raise an encumbrance against the department for the remaining expense balance to ensure simple review of department’s spending against budget. For example, paying
Example -
$12,000 paid on July 1, 20XX for a 12 -month subscription at the start of our fiscal year (July 1st) would result in $1,000 in expense recognized in July, and $11,000 in the asset account Prepaid Expense. The Prepaid Expense, an asset account, would be amortized (expense recognized on the general ledger) at a rate of $1,000 per month, reducing the asset balance by the same.
Each month during close, the General Ledger Accounting team will reclass the expense balance for any invoices exceeding the $10,000 threshold that are to be used in future periods (where a period is defined as a contained duration during which our financial records are closed, most commonly one month). Each subsequent month, a single month’s fraction of the total life of the prepaid expense asset will be amortized to the original GL coding provided on the invoice’s RFP. The individual management reporting views will be encumbered so that the budget is shown as used based on the cash spent on the expense.
No additional burden is required on submission of RFPs, and those should continue to follow the process laid out in Accounts Payable.
month subscription to:
RFP submitted by department to pay $12,000
Dr 76405 - Subscriptions $12,000
Cr 21101 - Vouchers Payable $12,000
At month end, Finance determines that the following accounting treatment is required:
Dr 12201 - Prepaid Expenses $11,000
Cr 76405 - Subscriptions $11,000
An encumbrance will be raised against the department for $11,000.
The next month, and following months (until the full expense is recognized), Finance will:
Dr 76405 - Subscriptions $1,000
Cr 12201 - Prepaid Expenses $1,000
The encumbrance will be reduced by $1,000.
Note - There is an exception to this process for prepaids related to Sodexo payments specific to the contractual arrangement with Sodexo as a vendor. The University is billed at the start of the fiscal year to retain a prepaid balance and subsequent billings throughout the year to maintain a balance. Only the Sodexo prepaid arrangement is not subject to this processContact Finance for further details if required.