Before You Start

This guide assumes you have a Xero Standard or Premium subscription and a basic understanding of accrual accounting principles.

Overview

20 min
Setup Time
Intermediate
Difficulty
Monthly
Maintenance

What You’ll Learn

  • How to set up a dedicated Prepaid Expense asset account in Xero
  • Creating and managing automated amortization schedules
  • Ensuring accurate monthly expense recognition
  • Tips for month-end reconciliation of prepaid assets

1. Understanding Prepaid Expenses in Xero

Before utilizing Xero’s feature, ensure you have the necessary accounts:

Required Accounts

  • Prepaid Expenses (Current Asset)
  • Relevant Expense Account (e.g., Insurance Expense, Rent Expense)

Common Prepaid Items

  • Insurance Premiums
  • Annual Software Subscriptions
  • Rent Payments
  • Advertising Campaigns

2. Xero’s Built-in Amortization vs. Manual Entries

You have two primary ways to handle prepaid expenses.

Method A: Xero’s Built-in Amortization Feature

This is the automated way for Xero Standard/Premium users.

Pros:
  • Automated monthly postings.
  • Reduces manual errors.
  • Easy to track remaining balance.
Cons:
  • Requires initial setup.
  • Not available in Starter plan.
  • Less flexible for unique schedules.

Method B: Manual Journal Entries

This method provides full manual control.

Expert Tip: We strongly recommend leveraging Xero’s built-in Amortization feature. It automates the complex calculations and journal entries, saving significant time and reducing errors compared to manual methods.

3. Step-by-Step: Setting Up Prepaid Expenses

Here is the high-level workflow for clean prepaid expense management.

Here is a sample code block to illustrate the amortization schedule setup.

{
  "prepaid_item_name": "Annual Software License",
  "total_cost": 1200.00,
  "start_date": "2025-01-01",
  "end_date": "2025-12-31",
  "amortization_period_months": 12,
  "monthly_expense": 100.00,
  "asset_account": "810 - Prepaid Expenses",
  "expense_account": "420 - Software Expense"
}

4. Configuring Amortization in Xero

  1. 1

    Create a “Prepaid Expenses” Asset Account

    Navigate to Accounting > Chart of Accounts. Add a new account with the type “Current Asset”.

  2. 2

    Enter the Initial Bill/Invoice

    When creating the bill, code the full amount to your “Prepaid Expenses” asset account. Don’t code directly to an expense account yet.

  3. 3

    Create Amortization Schedule

    From the approved bill, click “Options” > “Create amortization schedule”. Define the expense account, start/end dates, and duration.

  4. 4

    Review and Post

    Review the generated schedule to ensure monthly amounts and total duration are correct. Then post the schedule to activate it.

Common Error: Incorrect Account Type

Always ensure the initial bill for a prepaid expense is coded to a Current Asset account, not directly to an expense account. The amortization schedule will then handle the monthly transfer to the expense account.

5. Month-End Review and Reconciliation

Month-End Checklist

  • Review all active amortization schedules in Xero.
  • Verify monthly expense entries have been automatically posted.
  • Reconcile the Prepaid Expenses asset account balance against your records.
  • Ensure no duplicate manual expense entries have been created.

Need Help?

Get Expert Xero Support

Need a hand optimizing your Xero setup for prepaid expenses? Our specialists are here to help ensure your accruals are perfect.

Contact an Expert