As we know that the accounts are maintained for a particular financial year and the final accounts are prepared on last date of financial year. Various expenses are incurred during the financial year. But it is not necessary that all the expenses are hundred percent related to only one financial year. There may be so many expenses which may be related to next financial year also. In that case an accountant must show the expenditures in profit and loss account, only relating to that particular financial year to know the actual picture of the profit or loss of the company. Therefore,  it is very important to allocate the expenditure according to period wise.

For example a company has paid insurance premium for Rs.500000/- from 1.10.15 to 30.9.16. If we calculate the correct amount to be booked as expenditure for financial year 2015-16, that will be Rs.250000/= i.e. from 1.10.15 to 31.3.16 (for six months). The balance amount of Rs.250000/= shall be called as prepaid expenses and will be carried forward to next year.

Treatment of Prepaid Expenses in Final Accounts

Prepaid expenses are first deducted from respective expenses in profit and loss account and are shown in asset side of balance sheet.