What Is a Prepaid Expense?

A prepaid expense is a payment made in advance for goods or services that will be received in the future.

In accounting, prepaid expenses are recorded as a current asset on the balance sheet at the time of payment. As the benefit is used over time, the amount is gradually recognized as an expense in the income statement.

This treatment follows the accrual accounting rule (matching principle), which ensures that costs are recorded in the same period as the benefit they provide — not simply when cash is paid.

Prepaid expenses help UAE businesses present accurate financial statements and remain compliant with proper accounting standards.

Key Characteristics of Prepaid Expenses

• Asset: A prepaid expense is initially classified as an asset, as it represents a future economic benefit to the business.

• Current Asset: Prepaid expenses are usually shown as current assets, since the benefit is typically consumed within 12 months.

• Expensed Over Time: The cost is recognized gradually, usually on a monthly basis, rather than being expensed in full at the time of payment.

• Accrual Accounting: Prepaid expenses are a core part of accrual accounting, which is essential for accurate financial reporting and UAE corporate tax calculations.

Common Examples of Prepaid Expenses in the UAE

• Prepaid Trade License: Paying the annual UAE trade license fee upfront for 12 months.

• Prepaid Visa Costs: Paying employee or owner visa fees upfront, typically covering a 2-year validity period.

• Software Subscriptions: Paying for a year of software access at the beginning of the term.

• Office Rent: Paying several months of office or warehouse rent upfront.

Almost every UAE business will have at least one prepaid expense on its balance sheet.

Accounting Example: Prepaid Trade License Fee

A UAE company pays AED 12,000 for a 12-month valid trade license.

Initial Payment

At the time of payment, the full amount is recorded as an asset:

• Debit: Prepaid Trade License (Asset) - AED 12,000

• Credit: Cash / Bank - AED 12,000

At this stage, no expense is recognized yet because the license benefit will be used over the next 12 months.

Monthly Adjustment

At the end of each month, one month of the license cost is expensed:

• Monthly expense: AED 1,000 (12,000 ÷ 12)

Journal entry:

• Debit: Trade License Expense — AED 1,000

• Credit: Prepaid Trade License — AED 1,000

This reduces the prepaid asset and ensures the cost is matched correctly to each accounting period.

How Naqood Handles Prepaid Expenses Automatically

With Naqood’s purchase module, prepaid expenses are handled automatically. When recording a purchase, you simply select how long the expense covers (for example, 12 months for a trade license or 24 months for a visa). Naqood then automatically posts the prepaid transaction and creates the monthly expense entries, ensuring accurate financials, proper accrual accounting, and corporate tax–ready reports without manual journals.

Frequently Asked Questions (FAQ)

1. What is a prepaid expense in UAE accounting?

A prepaid expense is a cost paid in advance for goods or services that will be used in the future. In UAE accounting, it is recorded as a current asset and expensed over time as the benefit is consumed, following the accrual accounting principle.

2. Are prepaid expenses allowed under UAE Corporate Tax?

Yes. Prepaid expenses are fully allowed under UAE Corporate Tax, provided they are recorded correctly under accrual accounting. Only the portion relating to the current financial period can be deducted when calculating taxable profit.

3. Can I deduct the full prepaid expense in one year for corporate tax?

No. For corporate tax purposes, you can only deduct the portion of the prepaid expense that relates to the current tax period. The remaining balance must stay on the balance sheet and be deducted in future periods.

4. How are trade license costs treated under corporate tax?

Trade license fees are typically paid for 12 months and must be treated as a prepaid expense. Only the monthly portion relating to the financial year can be deducted for corporate tax purposes.

5. How are visa costs treated in UAE accounting?

Visa costs are usually valid for two years and should be spread over the visa validity period. Each month, a portion of the cost is expensed, while the remaining amount stays recorded as a prepaid expense.

6. Do prepaid expenses affect VAT in the UAE?

VAT treatment depends on the invoice date and payment date. VAT is generally claimable based on the tax invoice, not when the expense is recognized in accounting. This means VAT may be recovered immediately even though the expense is recognized over time.

7. Can VAT be claimed on prepaid expenses?

Yes. If a valid UAE tax invoice is received and the expense is VAT-eligible, VAT can usually be claimed in the same VAT return period - even if the cost is recorded as a prepaid expense in accounting.

8. Are prepaid expenses shown on the balance sheet?

Yes. Prepaid expenses appear under current assets on the balance sheet until they are gradually expensed through monthly adjustments.

9. Why are prepaid expenses important for accurate financial statements?

Prepaid expenses ensure that costs are matched to the period in which they provide value. This prevents overstating expenses in one period and understating profits in another, which is especially important for corporate tax accuracy.

10. What happens if prepaid expenses are recorded incorrectly?

Incorrect treatment can lead to:

• Overstated expenses

• Incorrect taxable profit

• Corporate tax compliance issues

• Problems during audits or FTA reviews

Proper prepaid expense accounting helps maintain clean, compliant financial records.