There’s no such thing as a prepayment
The battle to remove prepayments from accounting vocabulary is probably not winnable, but we can help our students by being clear about how we describe them.
Bringing up four teenage boys, mealtime conversations were often crowded and rowdy affairs. This was encouraged on the basis that arguments develop social, intellectual and emotional intelligences.
I use the word argument in the positive sense of reaching a better collective understanding of an issue. Subject matter was always secondary – we argued about anything, and still do.
A good example was the long-running exchanges about “pre-ordering“. One of the boys innocently reported that he’d pre-ordered a new video game. I said no, he hadn’t — he had ordered the game, not pre-ordered it.
He said the game had not been released yet so it couldn’t be ordered. I argued that the status of inventory had no impact on the semantics of ordering. In fact, before Amazon came along I couldn’t recall anybody pre-ordering anything. We placed orders at shops for items that weren’t available, but we never had to “pre-order” anything. And what’s more, I asked, if you did have to pre-order it, when would you place the actual order?
I was triumphant – the boys unmoved.
Life went on undisturbed, other than a potentially explosive episode when a friend of one of the boys popped in some weeks later and said in passing that he had pre-ordered something. The boys looked worried and begged me to let it go. That’s another story.
A few weeks later, I was sharing my frustration after teaching prepayments to my first year undergraduates. It was a concept that they found really tricky.
Immediately, one of the boys pops up “What’s a pre-payment Dad? Surely you can’t pre-pay something. Either it’s paid or it isn’t. Oh, and if it is pre-paid, when do you actually pay it?”.
My first thought was that encouraging debating skills was clearly a mistake, but his challenge lead me to some reflections about prepayments.
Once again, the language we use is unhelpful to teaching and learning. Pre-payment literally means before payment, but we actually mean that the transaction is post-payment and pre-expense activity.
By “prepayment” we mean pre-expense / post-payment.Admittedly, a bit of a mouthful
So firstly, the “pre–” in prepayment is misleading but secondly, “payment” is also problematic. Most textbooks are clear about prepayments being paid. This one is typical.
“An expense paid for in advance of the benefit being received.”
I’m not so sure. Imagine that on 10 March 2021, a business is invoiced £30,000 by its agency for an ad campaign that will run over the months of March, April and May. The costs of the campaign are to be allocated equally over the three months. The agency’s invoice is due for payment on 24 April 2021.
Ignoring sales and value added taxes, at the end of March the entity has incurred expenses of £10,000, it has “prepayments” of £20,000 and a liability to the agency of £30,000. It has paid nothing.
A prepayment is nothing of the sort: it’s not pre-payment and it’s not necessarily a payment. I prefer the term “deferred expenses” and this sits nicely with its cousins.
|Deferred expenses||Accrued expenses|
|Accrued income||Deferred income|
The battle to remove “prepayments” from accounting vocabulary is probably not winnable, but we can help our students by being clear about how we describe expenses invoiced in advance, whether they are paid or not.