Prepayments in Xero: spread a yearly bill so one month's profit is not wrecked

Short answer: a prepayment is a cost you pay now that covers later months, such as a year of insurance or an annual software plan. If the whole bill is coded to the expense account, the month you pay it shows a huge cost and a poor profit, and the next eleven months look better than they really are. To spread it in Xero, code the bill to a Prepayments current asset account instead, then set up a repeating manual journal that moves one month’s share from Prepayments to the expense account each month. The year’s total cost does not change and neither does your cash: the money still leaves the bank on the day you pay. What changes is that each month’s Profit and Loss shows that month’s real cost, so you can compare one month with the next.

Xero does not spread a bill automatically. Owners and bookkeepers have asked for built-in prepayment schedules on Xero’s product ideas forum; until then it is a journal you set up once, or an add-on app (Spread and Dext both offer prepayment schedules). Menu names move between Xero releases; if a label below does not match your screen, search Xero Central for “repeating manual journal”.

What a prepayment does to the months

	Coded straight to Insurance	Coded to Prepayments and spread
Month you pay	The whole year’s cost	One month’s share
The other 11 months	Nothing	One month’s share each
Year’s total cost	Same	Same
Bank balance	Down by the full amount on the day you pay	Down by the full amount on the day you pay
Balance Sheet	Nothing	A Prepayments asset that falls to zero over the year

A worked year: a physio clinic’s insurance

An Australian physio clinic takes about $42,000 a month in sales (all figures excluding GST). Its other costs (wages, rent, consumables, software) are about $33,000 a month, so a normal month makes about $9,000 before insurance. On 1 July it pays $8,400 for a year of professional indemnity and business insurance, covering July to June, which is also its financial year.

Coded straight to Insurance, the Profit and Loss reads:

Month	Insurance	Net profit
July	$8,400	$600
August to June (each)	$0	$9,000
Year	$8,400	$99,600

July looks like the clinic nearly broke even, and every other month looks $700 better than it really is. If the owner compares July with June, or decides in August whether they can afford a new hire, they are working from the wrong number.

Spread as a prepayment, $8,400 over 12 months is $700 a month:

Month	Insurance	Net profit	Prepayments on the Balance Sheet at month end
July	$700	$8,300	$7,700
August	$700	$8,300	$7,000
September to May (each)	$700	$8,300	falls by $700 a month
June	$700	$8,300	$0
Year	$8,400	$99,600

Same year, same $99,600, same cash. Every month now shows the clinic’s real run rate of $8,300, and a month that comes in below that is worth asking about. Only the timing within the year moved.

How to set it up in Xero

1. Check you have a Prepayments account. In Accounting > Chart of accounts, look for a current asset account called Prepayments. Xero’s default chart usually includes one; if yours does not, add it (type: Current Asset).
2. Code the bill to Prepayments. Enter the insurance bill (or reconcile the payment) with the full $8,400 coded to Prepayments, not to Insurance. GST is claimed as normal on the bill.
3. Create a repeating manual journal. Go to Accounting > Manual journals, choose New repeating journal, set it to repeat monthly on the last day of the month, starting in July, with an end date in June (12 journals).
4. Fill in the two lines: debit Insurance $700, credit Prepayments $700, with no GST on either line (the GST was handled on the bill). Give it a narration such as “Insurance 1/12, policy July to June”.
5. Decide on cash basis. If you also read reports on cash basis, untick Show journal on cash basis reports so the cash view still shows the full payment in July (cash vs accrual in Xero explains why).
6. Check it at month end. On the Balance Sheet, Prepayments should equal the months still to come: $7,700 at the end of July, $0 at the end of June. A balance left after the policy ends means a journal is missing or one too many ran.

The same steps work for any bill that covers several months: annual software plans, registrations and licences, memberships, and rent or subscriptions paid quarterly in advance.

When it is worth doing

• Worth it: a bill that is large next to a normal month’s profit (above, $8,400 against $9,000) and covers three months or more. Those are the bills that make one month look like a crisis.
• Not worth it: small annual bills, say a few hundred dollars. The distortion is smaller than normal month-to-month noise; leave them in the expense account and know they are there.
• Ask your accountant about the year end. Spreading in your monthly reports does not change the year’s profit when the cover sits inside one financial year, as in the example. When it runs across two years, the split and the tax treatment are your accountant’s call; in Australia, for example, many small businesses can claim prepaid expenses of up to 12 months in the year they are paid.

The opposite case is an accrual: a cost that belongs to this month but has not been billed yet (a late utilities or rent bill). Profit looks too good this month and too bad when the bill arrives. Accruals in Xero shows that journal, and the month-end checklist covers both.

Common questions

What is a prepayment in Xero? A cost you have paid that covers future months, held as a current asset on the Balance Sheet and moved to the expense account one month’s share at a time with a manual journal.

How do I spread annual insurance over 12 months in Xero? Code the insurance bill to a Prepayments current asset account, then create a repeating manual journal for 12 months that debits Insurance and credits Prepayments with one twelfth of the bill each month.

Does Xero do prepayments automatically? No. Xero does not spread a bill by itself. You set up a repeating manual journal once per bill, or use an add-on app that creates the journals for you.

Does a prepayment change my cash flow? No. The money leaves the bank the day you pay the bill. A prepayment only changes which months the cost shows in on the Profit and Loss; the bank balance and the cash flow are the same either way.

Does a prepayment change my profit for the year? Not when the cover falls inside one financial year: the 12 monthly shares add up to the bill. It moves cost between months, and between years only when the cover crosses a year end.

Where does a prepayment show on the Balance Sheet? Under current assets, usually as Prepayments. It starts at the full bill and falls each month as the journal moves a share to the Profit and Loss. How to read a Balance Sheet in Xero covers the rest of that report.

Is a prepayment the same as a customer paying me in advance? No. That is the other way round: money received for work not done yet, held as a liability (often called deferred or unearned income) until you deliver.

Spot the month that looks wrong before you worry about it

A yearly bill coded to one month is one of the most common reasons a month looks bad for no good reason. ReportPilot reads your Xero figures and emails you every Monday in plain English: how last month’s profit compared, which line drove the change, and any cost line running well above its usual level, so an annual bill that landed in one month is named instead of found by accident. It does not create journals or change anything in Xero: it asks for read-only access, and there is a 14-day free trial with no card.