Prepaid expenses procedure

Prepaid expenses is an area in which a company's financial results can be manipulated by artificially capitalizing expenses that should have been recognized under the matching principle. The following procedure is designed to reduce the risk of prepaid expense manipulation, as well as provide for a consistent method of charging these items to expense.

Initial Recognition of Prepaid Expenses

  1. When coding supplier invoices for entry into the accounting system, obtain written approval from the assistant controller that a billing should be coded as a prepaid expense. Otherwise, the default entry is to record an expenditure as a expense.
  2. Verify that the item to be coded as a prepaid expense is equal to or greater than the company's minimum capitalization limit of $______. If not, then charge it to expense in the current period.
  3. Copy the documentation associated with the item and store it in the prepaid expenses binder.
  4. Enter the prepaid item in the prepaid expenses amortization spreadsheet, noting the beginning and ending dates of the amortization period, as well as the amount being capitalized, the name of the supplier, and the invoice number of the source document. Only straight-line amortization is allowed. If the item is not to be amortized yet, then note the reason on the spreadsheet.

Subsequent Amortization of Prepaid Expenses

  1. Verify the amortization calculations on the prepaid expenses amortization spreadsheet.
  2. Take the total amortization from the spreadsheet for the current period and enter it into the standard amortization journal entry.
  3. Have the assistant controller confirm the entry.
  4. Post the amortization entry.

Reconciliation of Prepaid Expenses

  1. At the end of each month, print the detail for the prepaid expenses account.
  2. Match the line items in the account to the supporting detail in the prepaid expenses amortization spreadsheet.
  3. If the supporting detail does not match the account balance, adjust the account balance with the approval of the assistant controller.

Note: If the balance for a prepaid line item falls below a designated minimum level, such as $250, consider writing off the entire remaining balance, thereby eliminating the need to continue tracking the remaining amortization of that item.