Prepaid Insurance: Definition, How It Works, Benefits, and Example

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This is because the initial journal entry is debited to the related account (i.e. prepaid rent or prepaid insurance) and then credited as cash. A prepaid expense ought not to be mistaken for an accrued expense. As previously explained, prepaid expenses are to be recorded as a type of current asset on the firm’s balance sheet. On the contrary, all accrued expenses have to be reported as a form of current liability on the balance sheet.

What is a Prepaid Expense?

The two most common uses of prepaid expenses are rent and insurance. Here, only the amount for 3 months is prepaid and it is recorded on the asset side of the balance sheet. Prepaid or unexpired expenses can be recorded under two methods – asset method and expense method. On 1 September 2019, Mr. John bought a motor car and got it insured for one year, paying $4,800 as a premium.

At the end of twelve months, the asset account would show a balance of zero for the insurance premium and a total of $12,000 in the insurance expense account. It would be entered into the general ledger as a debit of $12,000 to the asset account and a credit for the same amount to the cash account. Prepaid insurance is recorded in the general ledger as a prepaid asset under current assets. A current asset is a financial resource that can be easily liquidated, or converted to cash, in a year or less. In contrast, a non-current or fixed asset, like real estate, cannot be easily liquidated in a year or less.

Prepaid Insurance – Tired of Lumpy Expenses?

BlackLine Journal Entry is a full journal entry management system that integrates with BlackLine Account Reconciliations. It provides an automated solution for the creation, review, approval, and posting of journal entries. This streamlines the remaining steps in the process of accounting for prepaid prepaid insurance journal entry adjustments items. With amortization, the amount of a common accrual, such as prepaid rent, is gradually reduced to zero, following what is known as an amortization schedule. The expense is then transferred to the profit and loss statement for the period during which the company uses up the accrual.

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Prepaid Expenses: Explanation

Prepaid expenses cannot be deducted as they are paid because it would not be in line with the generally accepted accounting principles (GAAP). The journal entry above shows how the first expense for January is recorded. Again, anything that you pay for before using is considered a prepaid expense. In exchange, the insurance company usually offers the customer a discount on the premium price, so the business saves money on the policy. Whether new to BlackLine or a longtime customer, we curate events to guide you along every step of your modern accounting journey. Global brands and the fastest growing companies run Oracle and choose BlackLine to accelerate digital transformation.

BlackLine delivers comprehensive solutions that unify accounting and finance operations across your Oracle landscape. Make the most of your team’s time by automating accounts receivables tasks and using data to drive priority, action, and results. Monitor and analyze user performance, ensuring key actions quickly. The debit balance at the end of the year is shown on the asset side of the balance sheet and the amount is carried forward to the next year. As the name implies, Prepaid Expenses represent a prepayment for a future expense. The upsides and downsides related to prepaying an expense depend on the situation.

Financial Close

Therefore, as per the modern rules of accounting for assets an increase in assets will be debited. 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. While the concepts discussed herein are intended to help business owners understand general accounting concepts, always speak with a CPA regarding your particular financial situation. The answer to certain tax and accounting issues is often highly dependent on the fact situation presented and your overall financial status.

For example, if a business had purchased six months of insurance and decided to cancel the policy after two months, it could redeem the value of the four remaining unused months of coverage. In other words, it could get a refund of the premiums for those four months. In this way, prepaid insurance has economic value, not unlike an investment in stocks or bonds, that can be redeemed at a later time. Increase accuracy and efficiency across your account reconciliation process and produce timely and accurate financial statements.