When is a Prepayment not a Prepayment: The curious case of the unpaid Prepayment
- Kevin Carr
- Jun 5
- 7 min read
Updated: Aug 26
Understanding prepayments in practice
Prepayments are a familiar concept to most accountants. They represent payments made in advance for goods or services that will be consumed in future accounting periods. But what happens when the prepayment hasn’t been paid yet?
Let’s look at a scenario that raises this very question.
A realistic example: Annual insurance
Suppose a company has a financial year ending 31 December. In early December 2025, the business receives a quote for its annual property insurance. The policy covers the period from 1 January 2026 to 31 December 2026, with a total cost of $12,000. The company agrees to the quote, and an invoice is issued on 15 December 2025 with 30-day payment terms.
Here are the details:
Invoice date | 15 December 2025 |
Policy coverage | 1 January 2026 - 31 December 2026 |
Invoice amount | $12,000 |
Payment due date | 14 January 2026 |
Year end payment status | Unpaid |
If the invoice were paid immediately…
The accounting entry would be simple and universally accepted
DR Prepayments (Balance sheet)
CR Cash
The payment has been made, and the benefit relates to the next financial year - clearly a prepayment
But what if the invoice is unpaid at the year end?
In practice, when the invoice is received, the purchase ledger team may record
DR Insurance expenses (P&L)
CR Accounts payable/ Creditors (Balance sheet)
Later, the accountant would then post an adjusting entry to recognise a prepayment
DR Prepayments (Balance sheet)
CR Insurance expenses (P&L)
leaving us with a prepayment asset on the balance sheet, and a creditor liability, also on the balance sheet to reflect the invoice owing.
But this still leaves us with a question: if no cash has changed hands, can we truly call this a prepayment?
Some argue that if the invoice hasn't been paid, the business hasn’t made a prepayment at all—just a commitment. Should it instead be recorded as an “Other Debtor”, or should it even be included on the balance sheet?
Common real-life situations
These kinds of unpaid “prepayments” occur regularly. Here are some other examples seen in real life scenarios:
Conference room hire invoiced in December for a January event
Quarterly rent for January–March, invoiced in December but unpaid at year-end
Annual software license, invoiced in advance but not yet paid
In several organisations, there have been internal debates and even auditor challenges about whether these unpaid amounts should really be classified as prepayments.
So, what does the guidance actually say?
What do the Accounting Standards say?
1. Accrual Basis of Accounting
All major accounting frameworks (IFRS, US GAAP, and UK GAAP) agree on one thing: financial statements must be prepared using the accrual basis of accounting.
IFRS | “An entity shall prepare its financial statements… using the accrual basis of accounting.” | |
US GAAP | “Accrual accounting attempts to record the financial effects on an entity of transactions........ in the periods in which those transactions, events, and circumstances occur rather than only in the periods in which cash is received or paid” | |
UK GAAP | “The effects of transactions and other events are recognised when they occur (and not as cash or its equivalent is received or paid)...” |
The key takeaway from this is that the timing of payment doesn’t affect when the cost is recognised. If the benefit of a good or service occurs in a future period, and the company has a commitment, that’s what drives accounting—not the cash flow.
2. Definition of an asset
To decide whether we can call this a prepayment, even if unpaid, we first need to test if it qualifies as an asset.
IFRS | “An asset is a present economic resource controlled by the entity as a result of past events… that has the potential to produce economic benefits.” | |
US GAAP | “Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.” | |
UK GAAP | "An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits." |
In our example
The business has entered into an insurance contract (past event)
The insurance will provide cover in the next financial year (future economic benefit)
There is a legal obligation to pay (present control of the right/ obligation)
Therefore we can conclude that even if unpaid, the company controls the asset and so should be recognised.
3. Are Prepayments Defined?
Interestingly, the term prepayment isn’t precisely defined in most accounting standards. It’s usually treated as a subcategory of current assets and implied by broader asset definitions.
No standard distinguishes between paid and unpaid prepayments, and none require separate disclosures.
So, from a standards perspective, it’s correct to recognise a prepayment asset as long as the expense relates to a future period and the entity has committed to it, even if it hasn’t been paid yet.
Should I therefore not recognise a prepayment even before being invoiced?
When deciding to recognise a prepayment, we consider if we have a past event. In our example above, the past event is not receiving the invoice, rather entering into the insurance contract. Therefore, could one reasonably go even further than to wait for the invoice and recognise a prepayment as soon as the quote is accepted?
Well, as with a lot of accounting judgements, it depends, and in this case, probably not. When we talk about a past event in the context of recognising an asset, simply accepting a quote likely won't satisfy the criteria unless we have sufficient evidence of a binding obligation and the amount is measurable and probable. Receiving the invoice will provide this evidence and support for the amount, and so only at this stage would it be appropriate to recognise a prepayment.
What if we do meet the recognition threshold?
If rather than just accepting the quote, the company sign a binding contract in December 2025 for an agreed $12,000 premium, they could post a prepayment right away as follows;
DR Prepayments (Balance sheet)
CR Accrued expenses (Balance sheet)
And later, when the invoice is recieved;
DR Accrued expenses (Balance sheet)
CR Accounts payable/ Creditors (Balance sheet)
To summarise, the past event is entering into the binding commitment (e.g. signed contract), not just accepting a quote. The invoice provides support and documentation of the transaction, but is not the trigger itself. Therefore, even if a past event exists, we cannot recognise a prepayment unless the arrangement is enforceable, measurable, and provides a probable future economic benefit.
Prepayment recognition decision matrix
# | Condition | Yes | No |
1 | Is there a binding commitment? (e.g. signed contract, PO, acceptance of T&Cs that creates enforceable obligation) | Go to 2 | Do not recognise a prepayment |
2 | Does the payment relate to goods or services in a future period? | Go to 3 | Recognise expense in the current period |
3 | Is the cost reliably measurable? (price agreed or reasonably estimable) | Go to 4 | Wait for an invoice or a better estimate |
4 | Is the transaction probable and non-cancellable? | Go to 5 | Defer recognition until this can be established |
5 | Has an invoice been received or payment made? | Recognise prepayment DR Prepayments CR Accounts payable/ bank | Go to 6 |
6 | No invoice or payment yet — but terms are binding & measurable? | Recognise prepayment DR Prepayments CR Accrued expenses | Defer recognition until this can be established |
Why the Term “Prepayment” Can Be Misleading
The word “prepayment” naturally implies that a payment has occurred. You might ask, “How can I have a prepaid expense if I haven’t paid it?”
That’s a fair question. But in accounting, prepayments refer more to the timing of economic benefit recognition than the movement of cash. You could think of prepayments as "costs incurred or committed in advance of receiving the benefit, regardless of whether they’ve been paid".
In theory we could introduce sub-terms such as "Unpaid prepayments", or "Accrued prepayments", but in practice, these tend to confuse users of financial information, especially non-accountants, more than they help.
What About “Deferred expenses”?
The term deferred expense is sometimes used interchangeably with prepayment, but there’s a subtle difference:
Term | Usage |
Prepayment | Short-term costs paid or committed before benefit is received |
Deferred expense | Often used for long-term deferrals (e.g. >1 year), or industry-specific cases like insurance acquisition costs |
Examples of when to use "Deferred expenses":
Multi-year warranty payments
Sales commissions for a five-year contract
Insurance broker fees spread over the term of the policy (known as Deferred Acquisition Costs, or DAC, in the insurance sector)
Unless your prepayment extends well beyond 12 months or involves industry-specific treatment, it’s usually fine to stick with the term “Prepayment.”
Suggested Accounting Policy Memo
If you're an accountant, or working in finance, it may be helpful to document your company’s approach to unpaid prepayments. Here’s a sample memo you could tailor to your organisation:
Accounting Policy: Recognition of Prepayments
Objective:
To define the treatment of prepayments, including those where the invoice has been received but not yet paid, in line with relevant accounting frameworks.
Scope:
Applies to all prepaid costs (e.g. rent, insurance, software subscriptions) relating to future reporting periods.
Policy:
A prepayment shall be recognised when:
An invoice has been received or payment made, and
The benefit of the goods or services relate to a future accounting period, and
The transaction meets the definition of an asset under applicable standards.
The recognition of a prepayment is not dependent on whether it has been paid.
Presentation:
Recorded as a current asset on the balance sheet if the benefit is due within 12 months.
Captioned as "Prepayments" or "Prepayments and accrued income".
Long-term prepayments (if any) disclosed as non-current assets.
Review:
This policy will be reviewed annually or in response to changes in accounting standards.
Final thoughts: When is a prepayment not a prepayment?
So, when is a prepayment not a prepayment?
Strictly speaking, never, at least not if you're using accrual accounting principles. Whether or not the amount has been paid is irrelevant. If a business has committed to a service and will receive the benefit in a future period, then it qualifies as a prepayment and should be recognised as an asset.
Key takeaways
Accruals accounting focuses on when the benefit is received, not when cash is paid.
Prepayments should be recognised when the company has a present obligation and a right to future benefit.
Payment status doesn’t determine whether you record a prepayment.
Clarity, consistency, and substance over form are what matter most.
Found this useful?
Please share with your team or fellow accountants. Comment below with your thoughts or questions, and don’t forget to log this read as 10 minutes of CPD!
Comments