Why are prepaid expenses considered assets?

• A. They reduce liabilities
• B. The cost has already been incurred and will provide future benefit
• C. They are always cash equivalents
• D. They are revenue items

Answer: (B)

Prepaid expenses are payments made before receiving goods or services. They are assets because you’ve paid now for benefits you will receive in the future, giving you a present economic resource that the company controls and will convert into expense as the benefit is used. For example, paying for a year of insurance upfront creates a prepaid asset that is gradually expensed each month as the insurance coverage is consumed. That combination—cash outflow already occurred and future benefits will be realized—is exactly what makes prepaid expenses assets. They aren’t liabilities, they aren’t cash equivalents, and they aren’t revenue items.