---
title: "Prepaid Expenses & Deferred Revenue: Examples | MCC"
description: "Record prepayments and customer prepayments over time, with monthly entries and a year-end tie-out."
url: "https://mcc-solutionsnj.com/bookkeeping/guides/prepaid-expenses-and-deferred-revenue"
---

Bookkeeping guide · Updated October 12, 2026

# Prepaid Expenses and Deferred Revenue Basics

Paying for something long before you use it, or being paid long before you deliver it, creates timing problems in your books. Prepaid expenses and deferred revenue are the two ways accountants handle them.

By [Matthew Coleman](/about), MCC Solutions

**Quick answer.** A prepaid expense is paid before use. For a year of insurance paid at once, record it as an asset called prepaid insurance, then move one-twelfth to expense each month. Deferred revenue is the mirror case, where you are paid before you deliver.

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## Prepaid expenses

If you pay for a year of insurance in one payment, it would be misleading to show the entire cost in the month you paid. The coverage benefits twelve months. So you record the payment as an asset called prepaid insurance, then move one-twelfth to expense each month.

Other common prepaids are annual software subscriptions, domain and hosting plans, trade show fees paid ahead, and rent paid in advance.

## A simple monthly routine

Set up a schedule listing each prepaid item, the start date, the term and the monthly amount. At month end, record a journal entry that debits the expense and credits the prepaid asset. Many programs support recurring journal entries so you do not need to retype it.

At year end, the balance in prepaid assets should equal the unused part of what you bought. Compare it to the schedule. If it does not match, an entry is missing.

## Is it worth it for small amounts?

Not always. Many businesses set a threshold. Anything below it is expensed when paid. Above it, the item is spread. The threshold should be consistent and written down, and your CPA can suggest a sensible level.

The tax rules also allow some small prepaid items to be deducted when paid, under certain conditions. Check current IRS guidance or ask your tax preparer, since the books and tax return do not always have to match in treatment.

## Deferred revenue

This is the reverse. A customer pays for a year-long membership or a service package up front. You have their cash, but you have not earned it yet. You record a liability called deferred revenue, then move amounts into income as you deliver.

This applies to retainers, prepaid courses, annual maintenance plans, gift cards and deposits on work not yet started. Revenue is recognized as the service happens, or when the product is delivered.

## Mistakes to watch

A common mistake is recording a prepayment straight to income. That inflates one month and leaves later months looking thin. Another is failing to track refunds against deferred revenue when a customer cancels.

Review the balances quarterly. A deferred revenue liability that never decreases suggests you are not recognizing income. A prepaid asset that never decreases suggests you are not expensing it. Either way, your profit is misstated.

## A year-end tie-out

At year end, list every prepaid item with its remaining months, multiply by the monthly amount and compare the total to the prepaid balance in your books. Do the same for deferred revenue, adding up what is still owed to customers. These two tie-outs are quick and give your CPA clean support, which can lower the time they spend on your file.

## Worked example with numbers

A client prepays $3,600 for twelve months of service. Record debit cash $3,600 and credit deferred revenue $3,600. Each month, move $300 to revenue. After four months, $1,200 is revenue and $2,400 remains deferred.

On the expense side, a $1,200 annual software license paid in January is $100 a month of expense. After June, $600 has been used and $600 remains prepaid.

## Check your work

Keep a schedule for each deferral and prepaid item: start, end, total, monthly amount, balance. The schedule totals must match the balance sheet lines.

## Common questions

**Is deferred revenue a debt?**

It is a liability because you owe either the service or a refund, but it is not a loan. It is cleared by delivering what was promised.

**Do I need this if I use cash accounting?**

For taxes under cash accounting, income is generally counted when received. Books for management may still use deferral. Ask your CPA.

**Where does a customer deposit go?**

Usually into a liability account until the work is done. See your accountant if deposits are refundable or tied to contracts.

This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.

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