Xero Prepayments vs Bills: What's the Difference and How to Use Each

Xero has a feature called "Prepayments" in the Accounts Payable module. Many finance teams assume this handles prepaid expense accounting — but it does not. Understanding the difference between Xero's AP prepayment feature and proper prepaid expense accounting prevents a common and costly bookkeeping error.

Xero's AP Prepayments Feature

In Xero, you can record a "prepayment" in Accounts Payable when you pay a supplier before receiving a bill. This creates a credit on the supplier's account that can be applied to a future bill. It is designed for situations like paying a deposit to a supplier or making an advance payment against a purchase order.

This is a cash management and AP workflow feature. It has nothing to do with amortizing a prepaid expense over time. When you apply the prepayment to a bill, the full cost hits the expense account in one go — there is no spreading of cost over multiple periods.

Prepaid Expense Accounting in Xero

Prepaid expense accounting is something you have to build manually in Xero. You code the original payment to a balance sheet account (e.g., "Prepaid Insurance"), then post monthly manual journal entries to amortize the balance to the expense account over the coverage period. Xero has no built-in amortization schedule or automation for this.

When to Use Each

• Use Xero's AP Prepayment feature when: you pay a supplier before receiving a bill and need to track that credit against future invoices
• Use manual journal entry to a Prepaid Asset account when: you pay for something that benefits multiple future periods (insurance, software subscriptions, annual contracts)
• Do not use Xero's AP Prepayment to record a prepaid expense — the cost will hit the P&L in full when applied to the bill, not spread over the benefit period

The Confusion This Causes

Finance teams new to Xero often use the AP Prepayment feature for things like annual insurance or software licences, then wonder why the full expense appears on the P&L in one month. The answer is that they used the wrong tool. The AP Prepayment feature is for matching payments to bills — it is not an amortization mechanism.

A Cleaner Solution

Rather than managing amortization schedules manually in a spreadsheet alongside Xero, tools like CloseKit let you enter prepayments once, set the coverage period, and automatically calculate the monthly journal entries. The Xero integration (coming soon) will push those journals directly to Xero, eliminating the manual step entirely.