Prepayment
Rules
What is
a Prepayment?
Prepayments are payments that are made in one reporting period for goods or
services that will not be received until a future period or are received over a
longer period of time. This is often the case for expenses spread over a number
of months (subscriptions or insurance premiums) and where the expense relates
to separate financial periods.
Concept
The liability or the payment itself should be recognised in the first period it
applies. i.e. when the invoice comes in or the payment is made.
Some businesses will expense all payments (even where it is an expense that
covers the whole year) immediately, when the amount is below a predetermined
threshold. This threshold amount can be different for accounting purposes, as
distinct to any tax treatment, explained below.
A “Prepayment” is considered an asset to the business until such a time as the
goods or services have been received. So the payment or the recognition of the
purchase will be allocated to the “Prepayments” asset account initially.
Some
examples of common prepayments are:
·
Rent
·
Airfares
and accommodation
·
Subscriptions
·
Contract
payments
·
Insurance
·
Advertising
·
Booking
for conferences, major events etc
Prepayment
Rules for TAX - Small Business (Under $2milliion turnover)
You are allowed to claim items straight away if:
· Purchases less than $1,000
· Goods or services received in
the same income year as they were paid in
· Prepayment of salary or wages
(under a contract of service)
· Required to be incurred by
either:
o a law of the Commonwealth, a
State or Territory (for example, statutory fees or charges payable to a
government body such as vehicle registration fees)
o an order of a court of the
Commonwealth, a State or Territory
The 12
month rule – small business (Under $2 million turnover)
The 12 month rules applies If:
· You incur an eligible prepaid
expense for something to be obtained over a service period of 12 months or
less, and
· The service period ends in
the income year following the year you incur the expense. You can claim the
expense straight away.
Example
for immediate deductible expense:
A company makes a prepayment of $19,000 on 1st March 2013 for a service from
1st April, 2013 to 31st January, 2014. This satisfies the 12 month rule as it
runs for less than 12 months and finishes in the next financial year, therefore
the entire cost can be expensed immediately.
Item not
received until next tax year
If there is no part of the goods or services received until the next tax year
be sure to advise the tax agent to consider whether it is still a deductible
item for tax in this year. Typically if the item is not received or no part of
the service is provided until the following year it may not be deductible for
tax in the year of payment.
Goods or
Service received over more than one year
If the 12 month rule is not met you must treat it as a prepayment, for tax, and
apportion the payment over the period of the service/goods for up to 10 years.
Example
for prepayment:
A company makes a prepayment of $200,000 on 1st June, 2013 for goods to be
delivered in monthly batches from 1st August, 2013 to 30th July, 2014. This
does not satisfy the 12 month rule as it runs for more than 12 months and
covers 2 financial years. The payment will have to be apportioned out to relate
to the relevant financial year.
Bookkeeping
Processes
When you are accounting for prepayments, you need to create an asset account
for the initial payment. This then shows on the balance sheet how much prepaid
expense is still unapplied.
GST can be claimed at the time of payment regardless of whether you are on cash
or accrual reporting.
Processing
the Prepayment:
You have prepaid $4,400 on workers’ compensation insurance. You need to code
the payment to the Prepaid Asset. Note that you can claim all the GST up front.
(We have considered GST as 10% of the total amount to be paid).
Your
monthly journal entry: move the pro-rata ($4,000 / 12 = $333.33) amount from
the prepaid asset account to the relevant P&L expense account. GST has
already been accounted for therefore no GST reporting is required in this
journal.
