How to record prepayments

This article explains what prepayments are and how to record them in FreeAgent. It also explains how to reverse the prepayment.

What is a prepayment?

If you need to record costs that your business incurs on your profit and loss account at the time when the business uses what it's paid for, which wasn't when the cost was paid for, you need to record a prepayment.

For example, you might pay $600 for your business's home office insurance on 1st June 2021, which covers your office for a whole year up to 31st May 2022.

If your business prepares accounts to 31st March each year and you only include your office insurance in your accounts when you pay for it on 1st June 2021, the $100 worth of monthly costs for April and May 2022 will be recorded incorrectly. Instead of being recorded in your accounts prepared to 31st March 2023, they will be recorded incorrectly in your accounts prepared to 31st March 2022 instead. This will mean that your profit will be too low in your accounts prepared to 31st March 2022 and you might not pay enough tax.

Therefore, you need to remove the $100 costs for April and May 2022 from your profit and loss account prepared to 31st March 2022 by recording a prepayment.

As the $100 relates to your accounting year to 31st March 2023, you'll need to make sure you record it in your profit and loss account for that year by reversing the prepayment.

If you’re unsure about how to record a prepayment, please speak to your accountant.

How to record a prepayment in FreeAgent

You can record a prepayment in FreeAgent by creating journal entries.

To do this, navigate to the 'Accounting' tab at the top of the screen and select 'Journal Entries' from the drop-down menu.

Next, select 'Add New Journal Entries'.

For the example above, you would need to create two journal entries for the original prepayment of $100, dated 31st March 2022:

• Debit code ‘620 Prepayments’
• Credit the code where the original cost was recorded in your accounts - in the example of office insurance, this is ‘364 Insurance’.

How to reverse the prepayment

You’ll also need to record the costs in the relevant accounting year by reversing the prepayment.

To do this, navigate to the 'Accounting' tab at the top of the screen and select 'Journal Entries' from the drop-down menu.

Select ‘Actions’ on the right-hand side of the relevant journal entries and select ‘Reverse in new journal entries’ from the drop-down menu.

This will create a reversed set of those journal entries. Choose the beginning of your new accounting year as the date of the reversal, ‘01 Apr 22’ for the insurance example, and enter a description in the field provided.

Select ‘Create Journals’ at the bottom of the screen to complete the process. Find out more about how to copy or reverse journal entries.