Firstly, let’s Assume a company ABC purchases insurance premium for the upcoming 12-month period and pays $180,000 upfront for it. So, ABC Company will initially book the full $180,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash. Also, Each month, you would make an adjusting entry to expense $15,000 (1/12 of the prepaid amount) to the income statement through https://www.bookstime.com/ a credit to prepaid insurance and a debit to insurance expense. Finally, In the 12th month, the final $15,000 will be fully expensed and the prepaid account will be zero. Insurance is typically purchased by prepaying for an annual or semi-annual policy. Or, rent on a building may be paid ahead of its intended use (e.g., most landlords require monthly rent to be paid at the beginning of each month).

Every company pays insurance premiums either monthly, quarterly, or annually. So when a company has paid the insurance premium in advance for the next period, that extra payment is recorded as prepaid insurance on the Asset side of the Balance sheet. So every company treats it as an asset, and when the period comes, the appropriate amount is shown as an expense under the Insurance expense.

Prepaid Insurance in Balance Sheet

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. For example, if you had large copying machine which you leased by a company for a period of 12 months, the company benefits from its use over the full-time period. So, Recording an advanced payment made for the lease as an expense in the first month would not adequately match expenses with revenues generated from its use.

• 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.
• This journal entry credits the prepaid asset account on the balance sheet, such as Prepaid Insurance, and debits an expense account on the income statement, such as Insurance Expense.
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• As the insurance will not be used until and unless the first quarter of next year arrives, it will be reflected under the Asset side of the company as prepaid insurance.
• What was not stated in the first illustration was an assumption that financial statements were only being prepared at the end of the year, in which case the adjustments were only needed at that time.

This records the prepayment as an asset on the company’s balance sheet. An amortization schedule that corresponds to the actual incurring of the prepaid expenses or the consumption schedule for the prepaid asset is also established. If the prepaid insurance account is not adjusted in tandem with the portion of the insurance that has expired, it will lead to errors in reporting the assets and expenses of the company. Therefore, timely and accurate adjustments to the prepaid insurance account are essential for correct financial statements per time.

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Since the prepayment is for six months, divide the total cost by six ($9,000 / 6). First, debit the Prepaid Expense account to show an increase in assets. Although Mr. John’s trial balance does not disclose it, there is a current asset of $3,200 on https://www.bookstime.com/articles/prepaid-insurance-journal-entry 31 December 2019. Thus, what has been paid for remains an asset unless it is fully used. The trial balance, drawn up on 31 December 2019, assumed that he had no other insurance and his insurance expenses account would show a balance of $4,800.

When amortizing prepaid expenses, companies must debit the expense account and credit the prepaid expense account. Journal entries must be recorded accurately to ensure that the accounting books are correct. Thus, prepaid expenses are the expenses of the business that are paid in advance, but the benefit of the same will be received in future years. These expenses are the company’s current assets and are reported in the company’s balance sheet at the end of the accounting period. The expense is always recognized when realized, and this prepaid expense is shown under the head current asset in the company’s balance sheet. It is important to note that the process of recording any prepaid expense only takes place in accrual accounting.

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• Customarily the asset could then be removed from the accounts, presuming it is then fully used up and retired.
• 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.
• 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.
• As the prepaid expense expires in a given accounting period, accountants record a journal entry for the expiration as an expense.
• When a business pays for these expenses in advance, they are recorded as assets on the balance sheet.

These expenses are initially recorded as current assets, but the benefits of the same will be realized in future years. The most common example of prepaid expense is the insurance premium which is paid in the middle of the accounting period for 12 months. Half of the insurance premium paid will be booked as an expense in the same accounting year in which it is paid because it is only related to that accounting period. Therefore, the same will be recorded as prepaid expenses in the company’s books of accounts in the accounting year in which it is paid.

Pre Paid Expense Meaning, Journal entry and Effect on financial statements

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. A prepaid expense journal entry is a transaction recorded in the accounting books to recognise an expense that has been paid in advance. The journal entry debits the prepaid expense account and credits the cash account, reflecting the payment made. As time passes, the prepaid expense account is gradually reduced and transferred to the appropriate expense account. 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.

They could also choose to make the adjusting entry once, at the end of each fiscal year. Accurately accounting for business transactions, including prepaid expenses, is essential for ensuring accurate financial statements. At this point, recording a summarized scope of them as a single journal entry can sometimes be better than per transaction entries. Various types of spending can be considered a prepaid expense, including prepaid rent, insurance premiums, and prepaid advertising.

Journal entry of prepaid insurance: example 1

Prepaid expense is first recorded as an asset and later debited as an expense. Hence, it can be recorded by using the asset method and expense method of accounting. According to the terms and conditions, the current year’s full rent must be paid in advance, which is ₹1,80,000. Prepaid expenses help you lock in a product or service at the current market price. For example, if you believe fuel prices will go up next month, you may want to prepay for fuel to avoid paying extra when the price rises. As each month passes, adjust the accounts by the amount of rent you use.