A business buys one year of general liability insurance in advance, for $12,000. 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.
One objective of the adjusting entry is to match the proper amount of insurance expense to the period indicated on the income statement. Prepaid insurance is commonly recorded, because insurance providers prefer to bill insurance in advance. If a business were to pay late, it would be at risk of having its insurance coverage terminated.
The insurance expense account increases by the debit entry while the prepaid insurance account decreases by the credit entry. It is important to note that the process of recording any prepaid expense only takes place in accrual accounting. In this article, we will be discussing the prepaid insurance journal entry with some examples.
Prepaid Insurance Journal Entry
Let’s assume that a company is started on December 1 and arranges for business insurance to begin on December 1. On December 1 the company pays the insurance company $12,000 for the insurance premiums covering one year. The company will record the payment with a debit of $12,000 to Prepaid Insurance and a credit of $12,000 to Cash. To get the insurance expense for each month we will divide $1,200 by the 12 months which gives us $100. This means that for one month, say between December 1, 2022, and December 31, 2022, $100 worth of insurance is used up. This means that at the end of one month, on December 31, 2022, the reporting amount of prepaid insurance on the balance sheet will be $1100 (i.e $1,200 – $100).
- Since the insurance lasts one year, we will divide the total cost of $10,000 by 12 (i.e we will adjust the accounts by $833 each month).
- In order to understand how prepaid insurance works, let’s take an example.
- In the company’s book, this prepaid insurance will be classified as an asset.
When an advance insurance payment is made, the prepaid insurance journal entry is a debit to the prepaid insurance account and a credit to the cash account. According to the accounting debit and credit rules, a debit entry increases assets, expenses, and dividends accounts while a credit entry decreases them. Prepaid insurance is an asset and going by the debit and credit rules, the prepaid insurance account increases by a debit entry while the cash account decreases by a credit entry. Nonetheless, when the prepaid insurance has been used and charged to expense, the adjusting entry for prepaid insurance would be a debit to the insurance expense account and a credit to the prepaid insurance account.
In the company’s book, this prepaid insurance will be classified as an asset. In this case, it will be classified as a current asset on the Balance Sheet because it covers and falls within one year. As the prepaid amount expires, the balance in Prepaid Insurance is reduced by a credit to Prepaid Insurance and a debit to Insurance Expense. This is done with an adjusting entry at the end of each accounting period (e.g. monthly).
Prepaid insurance journal entry
Then, in each successive month for the next twelve months, there would be adjusting entries of prepaid insurance that debit the insurance expense account and credit the prepaid insurance account by $100. 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.
- In this case, it will be classified as a current asset on the Balance Sheet because it covers and falls within one year.
- As the prepaid amount expires, the balance in Prepaid Insurance is reduced by a credit to Prepaid Insurance and a debit to Insurance Expense.
- Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract.
- 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.
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Journal entry of prepaid insurance when paid
While the insurance used for December ($100) will be reported on December’s income statement as an Insurance Expense. As shown above, the Prepaid insurance account is debited with $10,000 to show an increase in assets, and the Bank account is credited with an equal amount to show a decrease in cash. When insurance is due and its coverage expires for each quarter, the accounts will be adjusted by the amount of the policy the company uses. Since the insurance lasts one year, we will divide the total cost of $10,000 by 12 (i.e we will adjust the accounts by $833 each month). Premiums from short-duration contracts shall be recognized as revenue over the period of the contract in proportion to the amount of insurance protection provided. Now, that we understand this, what journal entries will one make to record the $100 worth of insurance used and the $1,100 worth of prepaid insurance remaining?
You can set the default content filter to expand search across territories. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
The prepaid amount will be reported on the balance sheet after inventory and could part of an item described as prepaid expenses. However, if the advance payment covers a longer period, then the portion of the unexpired prepaid insurance that has not been charged to expense within one year will be reported as a long-term asset. In order to understand how prepaid insurance works, let’s take an example. Assume ABC company buys one-year insurance for its truck and pays $1200 for this insurance on December 1, 2022.
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Prepaid insurance is nearly always classified as a current asset on the balance sheet, since 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. The income statement for the quarter ending will, therefore, show an insurance expense of $2,500 under the line item of Insurance Expense. Whereas, in the company’s balance statement, the closing balance of the current prepaid insurance account will show a balance of $7,500 ($10,000- $2,500) for the quarter ending.
A company’s property insurance, liability insurance, business interruption insurance, etc. often covers a one-year period with the cost (insurance premiums) paid in advance. The one-year period for the insurance rarely coincides with the company’s accounting year. Therefore, the insurance payments will likely involve more than one annual financial statement and many interim financial statements.
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Rather, they provide value over time; generally over multiple accounting periods. The reason is that the expense expires as you use it, thus, you can’t expense the entire value of the prepaid service immediately. So when making a journal entry for prepaid insurance, you record the prepaid expense in your business financial records and adjust entries as you use up the service. 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.
Prepaid rent and prepaid insurance are typical examples of prepaid expenses. When the insurance premiums are paid in advance, they are referred to as prepaid. 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.