Prepayment
Key Takeaways
- Prepayments are revenue that has been received but not yet earned.
- The aim of the prepayment is to match the expenses used in that period to the revenues raised in that period.
- Prepayment risk is risk concerned with payment of dues before their due date.
Prepayment is the payment of dues before their due date.
What is a prepayment example
For an interest payment due date scheduled on the 30th of each month, if an interest installment is paid before 30th in a month, it would amount to prepayment.
Prepayment meaning / Prepayment concept
The expenses and income recorded in the accounts should relate to the period of those accounts. Therefore when the amount paid or received for an expense or income does not match the amount incurred, then an adjustment must be made. This adjustment is better known as a prepayment.
The aim of the prepayment is to match the expenses used in that period to the revenues raised in that period. Prepayment plays an important role in making sure that the financial records show a true and accurate reflection of an organization’s activities in the balance sheet prepayment treated as a current asset. The main principle of treating the prepayments in the profit and loss is that prepayment is deducted.
Prepayments are revenue that has been received but not yet earned. That means we have received payment of an invoice but not yet completed the work. Expenses that have incurred but not yet recognized i.e., expenses that have already been paid but relate to the future.
Prepayment risk
Prepayment risk is risk concerned with payment of dues before their due date. Prepayment of a loan is considered as a risk. Prepayment risk includes two components, contraction risk, and extension risk. In Contraction Risk – Interest rates decline while in extension Risk – Interest rate increases.
What is the difference between prepayment and advance payment?
The prepayment occurs in case of debts and loans. Sometimes sellers ask for advance payment as insurance against non-payment.