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Insurance companies often offer incentives to customers who prepay their premiums, but this type of plan requires making a large lump-sum payment. ParticularsDebitCreditInsurance Expense A/c$2,000 To Prepaid Insurance A/c$2,000The income statement for the quarter ending will show an expense of $2,000 under the line item of Insurance Expense. The following journal entry will be passed and reflected in the books of accounts of XYZ company. Insurance ExpenseInsurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe.

Prepaid expenses cannot be expensed as soon as you pay for a service or goods because your business benefits from it over a period of time. And according to GAAP , when you record an expense, you must realize the benefit from the asset in the same accounting period. A prepaid expense is any expense you pay that has not yet been incurred. Also known as deferred expenses, recording these expenses is part of the accrual accounting process.

Overview: What is a prepaid expense?

In contrast, accrued expenses are costs incurred by a company but not yet paid for, typically due to the absence of an invoice (i.e. waiting on the bill). Stockholders’ equity because you collected the cash in advance. Contact us to learn more about prepaid insurance and if it’s right for you.

The adjusting entry on January 31 would result in an expense of $10,000 and a decrease in assets of $10,000 . prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract. 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. At the end of each accounting period, a journal entry is posted for the expense incurred over that period, according to the schedule. 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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Employers must pay at least 50% of the premium cost, but the employees’ share cannot exceed the lesser of 50% of the premium cost or 1.5% of the employees’ monthly gross earnings. If employers purchase an approved plan, the health care contractor is responsible for informing the employers whether they are responsible for contributing toward dependents’ coverage. By the end of the twelve-month coverage period, the entire insurance benefits are delivered, the total expenditure was expensed, and the corresponding asset on the balance sheet declines to zero. Adjusting journal entries are used to adjust the balances in certain accounts due to the passage of time. Prepaid insurance coverage is considered to be a prepaid expense by accountants. That means that it has been paid before the coverage or service has been used. Prepaid insurance is counted as an asset just like any other type of prepaid expense.

Prepaid Expenses Example

Because they represent a future benefit owed to the company, companies list prepaid expenses first on the balance sheet in the prepaid asset account. Because companies anticipate them to be consumed, employed, or spent through regular business activities within a year. Consider the previous example from the point of view of the customer who pays $1,800 for six months of insurance coverage. Initially, she records the transaction by increasing one asset account with a debit and by decreasing another asset account with a credit.

The $50,000 balance in prepaid expense appears on the balance sheet for the month, while the $10,000 rent expense appears on the income statement. As part of the rental agreement, the landlord requests the business prepay six months’ rent before occupying the property. Upon the initial payment, the journal entry recorded by the business debits $60,000 to prepaid expenses and credits $60,000 to cash. Both of these accounts are asset accounts, and the entire transaction affects the balance sheet only. 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 account, and a credit of $12,000 to the cash 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 account.

When would a prepaid insurance asset have a credit balance?

Thus, in accounting, the payments made for insurance are tentatively entered as assets. When an auto insurer receives a payment for six months of auto insurance coverage, it is initially recorded as an asset. Then the asset is converted to an expense one month at a time until the coverage expires. The insured will then make another payment for the next six months and the process starts again.

If you’re using manual ledgers for your accounting, you can create a spreadsheet outlining your monthly expenses that will need to be recorded in your general ledger as an adjusting entry. In the example below, the company made a $90 prepayment to the landlord for rent.

An Example of Prepaid Insurance Accounting

Harold Averkamp has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the https://www.bookstime.com/ materials on AccountingCoach.com. Prepayment is the satisfaction of a debt before its official due date, such as paying a mortgage loan off early.

• Paying upfront can help you avoid the rising cost of goods and services, receive a discount, and take advantage of tax deductions.
• This process will repeat itself over and over for as long as the insured maintains coverage with the insurer.
• Upon signing the one-year lease agreement for the warehouse, the company also purchases insurance for the warehouse.
• In many cases, yes, you will pay slightly less for a longer period of coverage than you will for monthly coverage.
• FastTrack company buys one-year insurance for its delivery truck and pays $1200 for the same on December 1, 2017.
• The prepaid expense appears in the current assets section of the balance sheet until full consumption (i.e. the realization of benefits by the customer).

The full value of the prepaid insurance is recorded as a debit to the asset account and as a credit to the cash account. Each month, as a portion of the prepaid premiums are applied, an adjusting journal entry is made as a credit to the asset account and as a debit to the insurance expense account.