Prepaid insurance premiums are the number of insurance premiums that a company has not due during the same accounting period, so the unexpired portion of this insurance will appear as an asset on the company’s balance sheet.
In simple terms, it refers to the portion of unpaid insurance premiums that are paid in advance by the company and are not yet due.
Premiums are the amounts paid by an organization on behalf of its employees and other policies offered by the business. Typically, premiums are paid monthly or quarterly. Undue and prepaid expenses are reported in the accounts under Current assets. Expenses for the period are shown on the income statement.
Is prepaid insurance an asset?
Fast Track purchased one-year insurance for its delivery truck and paid $1,200 for the truck on December 1, 2017. Now that you have pre-paid for the service you use, it will be classified as an asset
In this case, prepaid insurance would be classified as a current asset on the balance sheet as shown below.
This means that the monthly cost of insurance is $1200/12 = $100. The $100 worth of coverage ran out in the month between Dec. 1 and 31.
Let’s take a look at the balance sheet at the end of the month on December 31, 2017.
Note that the reported amount for prepaid insurance in balance sheet assets is $1200 – $100 = $1100.
Insurance used in December will be listed as an insurance expense on the December income statement. It is shown in the income example table below.
Prepaid Insurance Journal Entry
Assume that Company XYZ is required to pay employee liability insurance in the amount of $10,000 for the entire fiscal year ended December 31, 2018. The company had paid a full-year premium of $10,000 at the beginning of the first quarter.
The following journal entry will go through and will be reflected in Company XYZ’s accounting books.
Journal entry after payment of upfront premiums
- Prepaid insurance is debited to indicate the creation of an asset on the balance sheet
- Balanced accounting rules are given that the bank credits an equal amount (every credit has an equal debit)
Journal entry when prepaid insurance expires
When coverage expires, $2,000 will be deducted from the prepaid account each quarter and shown as an expense on the income statement for that reporting quarter
- The income statement at the end of the quarter will show an expense of $2,000 under the insurance expense item
- On Company XYZ’s balance sheet, the closing balance of the checking account prepaid account would show a balance of $8,000 ($10,000-$2,000) at the end of the quarter because the payables for the quarter were paid out during the period
- The amount payable and expensed during the quarter is also called period cost as it is the cost incurred during the period
- The process of periodically debiting an account is often called amortization
Adjusting Entry for Prepaid Expenses
It is often helpful to pass adjusting entries to balance the books, which prevents us from entering entries for new business transactions. To pass an adjusting entry, you need to deduct the actual expense and post it to the prepaid expense account throughout the amortization process. Advance payments will be credited to the NIL balance at the end of the accounting period and all expenses should be credited to the income statement.
