How is a prepaid expense classified before it is incurred?

A prepaid expense is classified as an asset before it is incurred because it represents a payment that has been made in advance for goods or services that will be received in the future. When a business pays for these expenses upfront, such as insurance or rent, it gains a future economic benefit. This future benefit is reflected on the balance sheet as an asset, as the company expects to utilize the services or goods paid for in the upcoming accounting periods.

In accounting, this treatment aligns with the accrual basis, where expenses are recognized when incurred rather than when paid. Therefore, until the prepaid expense is consumed or used, it remains recorded as an asset, recognizing that it still holds value for the company. Once the underlying benefit is realized, adjusting entries will be made to transfer the amount from the asset account to the expense account, reflecting the consumption of that prepaid resource.