So, we can make the journal entry for the $12,000 prepaid insurance on December 31, by debiting this $12,000 into the prepaid insurance account and crediting the same amount to the cash account. The journal entry is debiting insurance expense $ 1,000 and credit unexpired insurance $ 1,000. The unexpired insurance will be recorded as current assets on the balance sheet.
Journal Entry for Unexpired Insurance
Hence, prepaid insurance journal entry does not affect the total assets because it increases one asset account and decreases another asset account at the same amount. 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. On November 20, the payment is entered with a debit of $2,400 to Prepaid Insurance and a credit of $2,400 to Cash. Businesses must disclose prepaid insurance accurately in their financial statements to ensure transparency for investors, regulators, and stakeholders. The prepaid insurance will be allocated to the insurance expense base on the coverage time. The balance will be reversed from prepaid insurance to expense on the income statement.
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The company has paid $10,000 of the insurance premium for the entire year at the beginning of the first quarter. This adjusting entry will be repeated at the end of each subsequent month to recognize the insurance expense gradually over the year. Consequently, at the end of the month of January, when the company wants to record the insurance expense for the month, they will need to divide the amount paid ie. $24,000 by 12 months which will give the insurance expense for each month that is $2,000.
- The prepaid insurance expense account under the current assets in the balance sheet will still show the amount of $16,000.
- Prepaid expenses are then recorded by reducing the expense that was originally recorded.
- It’s like moving money from your savings account to your checking account—you haven’t lost anything, you’re just reallocating it.
- When you buy the insurance, debit the Prepaid Expense account to show an increase in assets.
- As prepaid insurance is an asset that will expire through the passage of time, the cost of expiration will need to be recognized as an expense during the period.
Prepaid Insurance Is What Type of Account?
Understanding prepaid insurance and its journal entries is essential for accurate financial reporting. 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. Practice these concepts regularly to build a strong foundation in accounting for prepaid expenses. Businesses often pay for insurance in advance, securing coverage for future periods. This prepaid expense is recorded as an asset rather than an immediate cost, impacting financial statements and tax reporting.
- The expense, unexpired and prepaid, is reported in the books of accounts under current assets.
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- As time passes and the insurance coverage is used, an adjusting entry is made to expense the portion of the prepaid insurance that has been used.
- This can be a challenge, particularly if the company has to make monthly payments.
- Since prepaid insurance provides future economic benefits, it is recorded as an asset and gradually expensed as the coverage period progresses.
- 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.
- The second journal entry shows how 1/12th of this amount is charged to expense in the first month of the coverage period.
What kind of account is a prepaid expense?
This is done with an adjusting entry at the end of each accounting period (e.g. monthly). One objective of the adjusting entry is to match the proper amount of insurance expense to the period indicated on the income statement. Companies often have to pay insurance fees in advance, which means they need to record the payments as current assets.
At the end of January, one month of insurance coverage has been used, so ABC Company needs to expense 1/12th of the annual premium. 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. For example, on September 01, 2020, the company ABC Ltd. pays $1,200 for one year of fire insurance which covers from September 01, 2020. 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. However, the rights to these future benefits or services rarely last more than two or three years. Although Mr. John’s trial prepaid insurance journal entry balance does not disclose it, there is a current asset of $3,200 on 31 December 2019.
Company
The journal entry is debiting insurance expenses and credit prepaid insurance. Passing adjustment entries to balance the books of accounts is often helpful, preventing one from making an entry for new business transactions. To pass an adjustment entry, one must debit the actual expense and credit the prepaid expense account throughout the amortization. This prepaid account will come to the NIL balance at the end of the accounting period and all the expenses accrued in the income statement. As time passes and the insurance coverage is used, an adjusting entry is made to expense the portion of the prepaid insurance that has been used.