Firstly, what is a prepaid expense?
A prepaid expense is a future expense that we have paid in advance for, such as a 12 month software subscription.
Secondly, why is there a need to adjust for prepaid expenses?
For Startups, it's important you implement good accounting principles from the start which will ease operational burden as you scale and also ensure you report EBIT in line with accounting principles.
What's the benefit of recording prepaid expenses in line with accounting principles?
It is best practice and there will be a favourable impact to your net profit and EBIT as the expense is spread over the subscription period.
What is the threshold for prepaid expenses?
Most businesses have an accounting policy in line with AASB which entails a minimum threshold to record a prepaid expense. Typically something like this:
No prepaid expense is required to be recorded on any transaction less than $5,000. This is the threshold we have determined to be immaterial to financial reporting.
What are the tax consequences of prepaid expenses?
the eligible service period for the expenditure is 12 months or less
the period ends no later than the last day of the income year following the year in which the expenditure was incurred.
To close it out, we recommend recording prepaid expenses in line with best practice from the start, using a minimum threshold. To help you achieve this here is a free prepaid expense template from us at The Startup Nerds.