What does the term 'prepaid expenses' refer to?

The term 'prepaid expenses' refers specifically to payments made for expenses that will be incurred in future periods. This accounting concept arises when a business pays for goods or services before actually receiving them. For instance, if a company pays its annual insurance premium upfront, it records this payment as an asset on the balance sheet, recognizing that the benefit of the expense will be realized over the course of the year. This aligns with the accrual accounting principle, which dictates that expenses should be recognized in the period they help generate revenue, even if cash is paid in advance. Therefore, the correct interpretation of prepaid expenses accurately represents their nature as future obligations that have been paid for in advance.