If you keep a ledger, enter the prepaid insurance payment as both a debit and credit. When the check for the deposit is cut and sent to the vendor, the business records the transaction on the balance sheet by debiting prepaid inventory and crediting cash. If the deposit will be used as a long-term security deposit, nothing else needs to be done until that money is applied against a final invoice or is returned to the business. Companies make prepayments for goods or services such as leased office equipment or insurance coverage that provide continual benefits over time.

Like all financial products, prepaid insurance has both advantages and disadvantages to consider. Insurance companies often offer incentives to customers who prepay their premiums, but this type of plan requires making a large lump-sum payment. Some insurers prefer that insured parties pay on a prepaid schedule such as auto or medical insurance. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

• It is essential to record it accurately on the balance sheet, according to accounting standards, as it can have a significant impact on financial analysis and decision-making.
• If you keep a ledger, enter the prepaid insurance payment as both a debit and credit.
• Recall that prepaid expenses are considered an asset because they provide future economic benefits to the company.
• Another possibility is that the company simply failed to pay the insurance company and the monthly adjusting entries caused the balance in Prepaid Insurance to become a credit balance.

On December 31, the company writes an adjusting entry to record the insurance expense that was used up (expired) and to reduce the amount that remains prepaid. This is accomplished with a debit of $1,000 to Insurance Expense and a credit of $1,000 to Prepaid Insurance. This same adjusting entry will be prepared at the end of each of the next 11 months. The effect of prepaid insurance on financial statements is that it increases a company’s assets while simultaneously reducing its cash balance or increasing its liabilities. When a company makes a payment for prepaid insurance coverage, it is recorded as a debit to the prepaid insurance account and a credit to cash or accounts payable. When the insurance coverage is used up over time, it is recorded as an expense on the income statement, which reduces net income and retained earnings.

DOCUMENTS FOR YOUR BUSINESS

When the policy goes into effect, you’ll then get the benefits of the coverage over a 12-month period. A prepaid expense refers to an amount that a company has paid and a portion or all of it will be an expense in a later accounting period. At the end of each month, an adjusting entry of $400 will be recorded to debit Insurance Expense and credit Prepaid Insurance. Prepaid insurance is insurance paid in advance and that has not yet expired on the date of the balance sheet. We've outlined the procedure for reporting prepaid expenses below in a little more detail, along with a few examples. Throughout the home insurance policy’s term, you will reduce the value of the asset.

• The amount in the Insurance Expense account should report the amount of insurance expense expiring during the period indicated in the heading of the income statement.
• Current liabilities are short-term liabilities of a company, typically less than 90 days.
• On December 1 the company pays the insurance company $12,000 for the insurance premiums covering one year.
• It also prepares an automatic monthly adjusting entry to debit Insurance Expense $100 and to credit Prepaid Insurance for $100.

Overall, understanding the balance sheet is important for any investor, creditor, or financial analyst. It provides an important snapshot of a company’s financial position and helps to ensure accurate financial reporting. In this journal entry, the company records the prepaid insurance as an asset since it is an advance payment which the company has not incurred the expense yet. This means the company should record the insurance expense at the period end adjusting entry when a portion of prepaid insurance has expired.

Prepaid insurance is a common financial term that many business owners and individuals alike are familiar with. Prepaid insurance refers to an advance payment made by an individual or business for a specific insurance policy covering a period of time, usually one year. This advance payment is recorded as an asset on a company’s balance sheet, and the amount paid is claimed as an expense over the course of the policy’s coverage period.

Prepaid Insurance vs. Insurance Expense

The prepaid insurance journal entry follows the same accounting principle for all prepaid expenses. Sometimes, in business, some expenses are paid for in advance even when the full benefits or services are yet to be received during that period. Such expenses are known as prepaid expenses which are one of the types of adjusting entries in accounting. Then you would enter a debit to the insurance expense account, increasing the value of the expenses. This reflects the depletion of the asset by the amount of one month's insurance, and it correctly enters the expense on the income statement.

Prepaid Expenses

In summary, prepaid insurance is classified as an asset because it represents a payment for future insurance coverage that will provide economic benefits to a company. Proper recording and reporting of prepaid insurance on a balance sheet is important for accurate financial statements and decision-making. As the amount of prepaid insurance expires, the expired deferred revenue portion is moved from the current asset account Prepaid Insurance to the income statement account Insurance Expense. This is usually done at the end of each accounting period through an adjusting entry. The term prepaid insurance refers to payments that are made by individuals and businesses to their insurers in advance for insurance services or coverage.

What Is Prepaid Insurance?

In summary, prepaid insurance is a current asset that is intended to provide coverage for a future period. It is reported on the balance sheet as either a stand-alone item or as part of a group of current assets. It’s important to understand that, while prepaid insurance is recorded as an asset, it is both expensed and taken off the balance sheet over time as benefits are incurred. Prepaid insurance is an important component of a company’s balance sheet and can have a significant impact on financial analysis. It is crucial for a company to accurately report their prepaid insurance to ensure that it reflects their liabilities and assets.

In this case, it is important for the company to record the payment as prepaid insurance. Prepaid insurance is a future expense, which you must pay upfront and receive its benefits over time. However, once you make the premium payment, the policy’s coverage becomes an asset, which diminishes over time during the coverage period. Accounts payable is a liability since it’s money owed to creditors and is listed under current liabilities on the balance sheet.

The initial entry is a debit of $12,000 to the prepaid insurance (asset) account, and a credit of $12,000 to the cash (asset) account. In each successive month for the next twelve months, there should be a journal entry that debits the insurance expense account and credits the prepaid expenses (asset) account. Insurance providers prefer to bill insurance in advance and so knowing the right journal entry for prepaid insurance is very important. For instance, the providers of medical insurance usually insist on advance payment, and if a business were to pay late, it would be at risk of having its insurance coverage terminated. Prepaid insurance is reported on the balance sheet as a current asset because the term of the related insurance contract that has been prepaid is usually for a period of one year or less.

If the prepayment covers a longer period, then classify the portion of the prepaid insurance that will not be charged to expense within one year as a long-term asset. Each month, you will need to move the used portion of the insurance payment to an expense account. At the end of the month, before the books are closed for the month, make one double entry to the journal. If the premium were $1,200 per year, you would enter a credit of $100 to the prepaid insurance asset account, decreasing its value.

At the end of any accounting period, the amount of the insurance premiums that remain prepaid should be reported in the current asset account, Prepaid Insurance. The prepaid amount will be reported on the balance sheet after inventory and could part of an item described as prepaid expenses. A common prepaid expense is the six-month insurance premium that is paid in advance for insurance coverage on a company’s vehicles. The amount paid is often recorded in the current asset account Prepaid Insurance. If the company issues monthly financial statements, its income statement will report Insurance Expense which is one-sixth of the six-month premium.

For example, assume ABC Company purchases insurance for the upcoming 12 month period. ABC Company will initially book the full $120,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash. Each month, an adjusting entry will be made to expense $10,000 (1/12 of the prepaid amount) to the income statement through a credit to prepaid insurance and a debit to insurance expense. In the 12th month, the final $10,000 will be fully expensed and the prepaid account will be zero.

Equity includes things like retained earnings, which are the profits that the company has earned and not paid as dividends. For example, on December 18, 2020, the company ABC make an advance payment of $6,000 for the fire insurance that it purchase to cover the whole year of 2021. Prepaid expenses are classified as assets as they represent goods and services that will be consumed, typically within a year. Liabilities are also usually listed in order of how quickly they need to be paid.