Define 'prepaid expenses'.

Prepaid expenses refer specifically to payments made in advance for future goods or services that will be received or utilized over a period of time. This type of expense is recorded as an asset on the balance sheet as it represents future economic benefits. For example, if a company pays for a year’s worth of insurance coverage upfront, the payment is classified as a prepaid expense until the coverage period begins. As time passes and the coverage is used, the expense is gradually recognized on the income statement, aligning the expense with the period during which the benefit is received.

Understanding prepaid expenses is essential for accurate financial reporting since it ensures that expenses are matched with the revenues they help generate, adhering to the accrual basis of accounting. Recognizing these expenses correctly allows for a more accurate depiction of the company's financial position and performance over time.