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We introduced you to accounts payable & accrued expenses as part of a balance sheet in our last blog, which was the second in our Reading Financial Statements Series©. In this and following blogs we will explore typical association balance sheet prepaid expenses in more detail. 

Another part of a financial statement deals with prepaid expenses. A prepaid expense is an expense an association has paid in advance. It is an asset of the association. The most common prepaid expense is an association’s annual insurance premium.

What Causes A Prepaid Expense To Occur?

Generally, prepaid expenses are recorded when an association has paid for something but has not yet received the benefit of the expenditure.

EXAMPLE: Prepaid Insurance

Let’s assume your association has a calendar year end (December 31). Your association’s insurance policy period runs from August 1 of the current year (CY) to July 31 of the next year (NY).  If your association pays the annual insurance premium of $12,000 in full on July 1, CY, how much will be recorded as an expense and a prepaid expense?

Since the annual premium is $12,000 and there are twelve months in the policy year, the expense for each month is $1,000 ($12,000 divided by 12 months). The expense for the current year will be for the period August 1 to December 31: five months. Five months at $1,000 per month equals $5,000 to be expensed in the current year.

What about the other $7,000 of our $12,000 premium?  We paid it all in the current year so why can’t we expense it all in the current year? The premiums paid this year that benefit the next year, through the end of the policy period on July 31, will be expensed next year. For this year, we need to account for the $7,000 that benefits next year as prepaid insurance expense and present the account as an asset on the balance sheet.

We ask the next question a lot because it is so important:

What Is Your Accounting Basis?

• Cash Basis: Revenues recorded when cash is received, expenses recorded when paid.
• Accrual Basis: Revenue recorded when earned/billed, expenses recorded when incurred.

Under the cash basis of accounting, the full $12,000 insurance premium would be recorded as an expense when the premium is paid. Using the accrual basis of accounting, the insurance premium is expensed in the current year ($5,000) and in the next year ($7,000) per the analysis above.

Full Accounting and Knowledge

We believe the full accrual basis of accounting provides associations and readers of financial statements with a more complete and accurate representation.

[ Blog/News ]

This blog, introducing you to balance sheets, is the first in our Reading Financial Statements Series©

What Is A Balance Sheet?

Balance sheets present the financial position of your association as of a certain date, usually the month or year end.

What Are The Classifications Of Accounts On My Association’s Balance Sheet?

• Assets
• Liabilities
• Equity or Funds

Assets

What the association owns or owns the rights to, including:

• Cash
• Assessments and other receivables
• Prepaid expenses
• Deposits

Liabilities

What the association owes or is obligated to pay, including:

• Accounts payable (unpaid vendor invoices)
• Accrued expenses
• Prepaid assessments
• Deferred revenues

Equity or Fund Balances

The association’s net worth. Generally, represents the cumulative revenues minus expenses over the life of the association since its inception.

Basis of Accounting

One of my favorite topics is “What basis of accounting is used to present your association’s financial statements?” Some balance sheet accounts will not be presented on financial statements if your association presents its financial statements using the cash basis of accounting.

Being aware of what you are reading, as well as what may be missing from the balance sheet you are reviewing is important to your understanding of the association’s financial position each month.

We will dive deeper into the individual accounts like cash and receivables in future blogs in this Series.  A short example of what to look forward to:

• Cash – Do you know what your bank accounts are used for? Do you verify balances? Are you pursuing returns over security?
• Receivables – Are you expecting to collect everything that is owed to the association? Did you bill for all services?
• Payables – How much does the association owe to vendors?
• Prepaid assessments – Are you shoring up today’s cash balances with money collected for future expenses?
• Operating Fund (Equity) – Does the association have excess funds, has it been over-spending?