What is a prepayment? Definition & examples

A prepayment is a payment made in advance for goods or services you'll receive in a future period. Because the benefit hasn't been consumed yet, the cost sits on the balance sheet as an asset until it's used — then it's released to the profit & loss over time.

In one sentence

You've paid the cash, but you haven't had the benefit yet — so it isn't an expense yet.

Everyday examples

• Annual insurance paid in one go
• Rent or rates paid in advance
• Software licences and subscriptions billed yearly
• Prepaid maintenance or support contracts

Why it matters

Expensing a big prepaid cost all at once makes one month look expensive and the rest look cheap. Spreading it gives a clean, comparable monthly P&L and a balance sheet that reflects value still to be used.

How it's accounted for

Post the cost to a prepayment (balance‑sheet) account, then release it to the P&L each month over the period it covers. See the worked entries in prepayment journal entry examples.

The automated approach

WorkWithLottie finds prepaid costs in Xero and manages the release schedule for you.

Related: Accruals vs prepayments · How to account for prepayments in Xero

Frequently asked questions

Is a prepayment an asset or an expense?

A prepayment is an asset on the balance sheet until the benefit is used. It's released to the profit & loss as an expense over the period it covers.

What's the difference between a prepayment and an accrual?

A prepayment is paid in advance of receiving the benefit (an asset). An accrual is a cost incurred before you've paid or been billed (a liability). They're mirror images.

How do you release a prepayment each month?

Debit the relevant expense and credit the prepayment (balance sheet) account with one period's share, repeating until the prepayment balance reaches zero.