Record a prepaid expense in your business financial records and adjust entries as you use the item. A common prepaid expense is the six-month insurance premium that is paid in advance for insurance coverage on a company’s vehicles. The amount paid is often recorded in the current asset account Prepaid Insurance.
- The company would reduce this account by the amount it pays the insurance company, simultaneously crediting its cash account.
- A business spends $12,000 in advance for liability insurance coverage for the next twelve months.
- When you prepay rent, you record the entire $6,000 as an asset on the balance sheet.
- Credit the corresponding account you used to make the payment, like a Cash or Checking account.
- The prepaid amount will be reported on the balance sheet after inventory and could part of an item described as prepaid expenses.
- Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.
The costs that have expired should be reported in income statement accounts such as Insurance Expense, Fringe Benefits Expense, etc. Unexpired insurance premiums are reported as Prepaid Insurance (an asset account). There are also cases when a business signs a contract with an insurance company but promises to make the payments later on.
For instance, many auto insurance companies operate under prepaid schedules, so insured parties pay their full premiums for a 12-month period before the coverage actually starts. The same applies to many medical insurance companies—they prefer being paid upfront before they begin coverage. Each month, an adjusting entry will be made to expense $10,000 (1/12 of the prepaid amount) to the income statement through a credit to prepaid insurance and a debit to insurance expense. In the twelfth month, the final $10,000 will be fully expensed and the prepaid account will be zero. According to generally accepted accounting principles (GAAP), expenses should be recorded in the same accounting period as the benefit generated from the related asset.
Terms Similar to Insurance Expense
In accounting, every financial transaction is recorded by two entries on the company’s books. These two transactions are called a “debit” and a “credit,” and together, they form the foundation of modern accounting. For example, assume ABC Company purchases insurance for the upcoming twelve month period.
ABC Company will initially book the full $120,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash. A business spends $12,000 in advance for liability insurance coverage for the next twelve months. The company records this expenditure in the prepaid expense account as a current asset. In each of the next 12 successive months, the business charges $1,000 of this prepaid asset to expense, thereby equably spreading the expense recognition over the coverage period. The term prepaid insurance refers to payments that are made by individuals and businesses to their insurers in advance for insurance services or coverage. Premiums are normally paid a full year in advance, but in some cases, they may cover more than 12 months.
Companies expend cash on items necessary to run a business, such as utilities, wages, maintenance, office supplies and other items. Journal entries typically follow the same format to record transactions in a company’s general ledger. Double-entry accounting requires both a debit and credit in each expense accounting entry. Since the insurance coverage began immediately, the company’s records should reflect that now it has only 11 months’ worth of insurance coverage, and afterward it would need to purchase it. There will no longer be a cash account because no cash is being exchanged. Instead, the balance equal to one month of insurance coverage ($2,800/12 or $233) is moved to the insurance expense account.
The insurance cost the business $2,800 and the bookkeeper made the following journal entry, which would reflect that the insurance company owes the business 12 months of insurance coverage. Every two weeks, the company must pay its employees’ salaries with cash, reducing its cash balance on the asset side of the balance sheet. If the balance sheet entry is a credit, then the company must show the salaries expense as a debit on the income statement. Remember, every credit must be balanced by an equal debit — in this case a credit to cash and a debit to salaries expense. Recording an advanced payment made for the lease as an expense in the first month would not adequately match expenses with revenues generated from its use. Therefore, it should be recorded as a prepaid expense and allocated out to expense over the full twelve months.
Example of Prepaid Insurance
As the prepaid amount expires, the balance in Prepaid Insurance is reduced by a credit to Prepaid Insurance and a debit to Insurance 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. To create your first journal entry for prepaid expenses, debit your Prepaid Expense account.
Thus, insurance expense represents the money a business paid to have insurance coverage for its various assets, its activities, and so on. When the insurance coverage comes into effect, it is moved from an asset and charged to the expense side of the company’s balance sheet. In this case, the company’s balance sheet may show corresponding charges https://www.bookkeeping-reviews.com/top-11-small-business-accounting-tips-to-save-you/ recorded as expenses. This is accomplished with a debit of $1,000 to Insurance Expense and a credit of $1,000 to Prepaid Insurance. This same adjusting entry will be prepared at the end of each of the next 11 months. At the end of each month, an adjusting entry of $400 will be recorded to debit Insurance Expense and credit Prepaid Insurance.
Every month or quarter, the bookkeeper will transfer the portion of the prepaid insurance that was paid for the period that has already passed to the insurance expense account. To illustrate how prepaid insurance works, let’s assume that a company pays an insurance premium of $2,400 on November 20 for the six-month period of December 1 through May 31. The payment is entered on November 20 with a debit of $2,400 to prepaid insurance and a credit of $2,400 to cash.
Meaning and Example of Insurance Expense
Basically, the cash discount received journal entry is a credit entry because it represents a reduction in expenses. When the insurance premiums are paid in advance, they are referred to as prepaid. At the end of any accounting period, the amount of the insurance premiums that remain prepaid should be reported in the current asset account, Prepaid Insurance. The discount allowed journal entry will be treated as an expense, and it’s not accounted for as a deduction from total sales revenue.
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The amount paid is charged to expense in a period, reflecting the consumption of the insurance over a period of time. If the retailer has incurred some insurance expense but has not yet paid the premiums, the retailer should debit Insurance Expense and credit Insurance Premiums Payable. However, gross margin ratio the premiums may be marginally higher to account for inflation and other operating factors. Insurance expense is that amount of expenditure paid to acquire an insurance contract. This expense is incurred for all insurance contracts, including property, liability, and medical insurance.