When the asset is charged to expense, the journal entry is to debit the insurance expense account and credit the prepaid insurance account. Thus, the amount charged to expense in an accounting period is only the amount of the prepaid insurance asset ratably assigned to that period. For example, the following journal entry shows an initial payment of $12,000 for one year of insurance, which is prepaid insurance journal entry adjustments recorded as an asset. 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.
Why is Prepaid Insurance an Asset?
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. 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. CARES Act Prepaid insurance appears in a company’s statement of financial position in the current asset segment as part of the prepaid expenses.
Journal Entries for Prepaid Expenses
- 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.
- To estimate the amount of a prepaid asset’s monthly benefit, divide the total cost of the asset by the number of months of benefits the asset represents.
- Note that the amount adjusted monthly is the total insurance payment divided by 12 which is the number of months in a year.
- Although Mr. John’s trial balance does not disclose it, there is a current asset of $3,200 on 31 December 2019.
At the end of the year, there may be expenses whose benefits have been received but not paid for and expenses that may have been paid, but their benefit will appear in the next financial year. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.
Income Statement Under Absorption Costing? (All You Need to Know)
The company usually purchases insurance to protect itself from unforeseen incidents such as fire or theft. And the company is usually required to pay an insurance fees for one year or more in advance. In this case, it needs to account for prepaid insurance by properly making journal entries in order to avoid errors that could lead to misstatement on both balance sheet and income statement. Prepaid expenses refers to payments made in advance and part of the amount will become an expense in a future accounting period. A common example is paying a 6-month insurance premium in December that provides coverage https://www.bookstime.com/ from December 1 through May 31.
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Prepaid insurance is initially recorded as a debit to the prepaid insurance account and a credit to the cash account, reflecting the cash outflow for the purchase of the insurance policy. If companies use the coverage for more than a year, prepaid insurance is a non-current asset or a long-term asset. Non-current assets are assets that are not expected to be converted into cash or consumed within one year or the operating cycle. Prepaid insurance is a type of prepaid expense, which is an expenditure paid in advance for a future benefit.
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). Prepaid Insurance is the insurance premium paid by a company in an accounting period that didn’t expire in the same accounting period. Therefore, the unexpired portion of this insurance will be shown as an asset on the company’s balance sheet.
Expense Method
- However, after adjusting entry at the end of the period for the insurance expense, the asset account will decrease while the expense account will increase.
- 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.
- To illustrate prepaid insurance, let’s assume that on November 20 a company pays an insurance premium of $2,400 for insurance protection during the six-month period of December 1 through May 31.
- By recognizing prepaid insurance as an asset and systematically expensing it over the coverage period, businesses can match expenses with the periods they benefit from.
- They include items such as prepaid insurance and prepaid rent and essentially represent the right to receive future services.
- Additionally, prepaid insurance is reported on the balance sheet as a current asset or a non-current asset.
Before diving into the wonderful world of journal entries, you need to understand how each main account is affected by debits and credits. GVG Company acquired a six-month insurance coverage for its properties on September 1, 2021 for a total of $6,000. Although Mr. John’s trial balance does not disclose it, there is a current asset of $3,200 on 31 December 2019.
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This team of experts helps Finance Strategists maintain the highest level of accuracy and professionalism possible. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. The matching principle is the basis for allocating expenses to the periods in which they are used or consumed.