Prepaid expenses are payments made in advance for goods or services that will be received in the future. These expenses are recorded as assets on a company's balance sheet until the benefits are realized. For example, if a business pays for a year's worth of insurance upfront, that payment is considered a prepaid expense. As time passes and the services are used, the prepaid expense is gradually expensed on the income statement. This process ensures that expenses are matched with the revenues they help generate, adhering to the matching principle in accounting.