What is Prepaid Insurance?
Prepaid Insurance is the amount of insurance premium paid by the company in an accounting period that didn’t expire in the same accounting period and therefore, the unexpired portion of this insurance will be shown as an asset in the balance sheet of the company.
In simple terms, it refers to that portion of the outstanding insurance premium which is paid by the company in advance and is currently not due.
An insurance premium is an amount that organizations pay on behalf of their employees and other policies that the business have rendered to. Generally, the insurance premium is paid on a monthly or on a quarterly basis. The expense which is unexpired and is prepaid is reported in the books of accounts under current assets. And the expense for that period is shown under the profit and loss statement.
Is Prepaid Insurance an Asset?
Fast Track company buys a one-year insurance for its delivery truck and pays $1200 for the same on 1st December 2017. Now that you have prepaid for services to be used, it is classified as asset
In this case, Prepaid Insurance will be classified as current assets on the Balance Sheet as shown below
This means that the insurance expense each month is $1200/12 = $100. For a period of one month between December 1st and 31st, $100 worth of insurance is used up.
Let us look at the balance sheet at the end of one month on December 31st, 2017.
Please note that the reporting amount of prepaid insurance on the balance sheet Asset is $1200 – $100 = $1100.
The insurance that is used for the month of December will be reported as Insurance Expense on December’s income statement. This is shown below in the sample income statement.
Prepaid Insurance Journal Entries
Let’s say XYZ company who needs to pay its Employee Liability insurance for the whole of a fiscal year ending 31-December-2018 amounted $10,000. The company has paid $10,000 of an insurance premium for the whole year at the beginning of quarter one.
The following journal entry will be passed and will be reflected in the books of accounts of XYZ company.
Journal Entry when Prepaid Insurance is paid
- Prepaid Insurance is debited which indicates the creation of an asset in the balance sheet
- Whereas Bank is credited with an equal amount which balances the rule of accounting (for each credit there is an equal debit)
Journal Entries when Prepaid Insurance is Due
When insurance is due, for each quarter i.e. $2,000 will be subtracted from the prepaid account and is shown as an expense in the income statement for that reporting quarter
- The income statement for the quarter ending will show an expense of $2,000 under the line item of Insurance expense
- In the Balance sheet of XYZ company, the closing balance of the current account prepaid account will show a balance of $8,000 ($10,000- $2,000) for the quarter ending as the amount due for the quarter has been expensed for that period
- Amount due and expensed this quarter is also known as the period cost as it the cost to be incurred in this period
- The process of deduction from the account periodically is often known as amortization
Adjustment entry for Prepaid Expenses
Passing adjustment entries to balance the books of accounts are often helping which avoids us to make an entry for new business transactions. To pass an adjustment entry you need to debit the actual expense and credit the prepaid expense account over the period of the amortization. The account which is prepaid will come to NIL balance at the end of the accounting period and all the expense accrued in the income statement.
Prepaid Insurance Video
This has been a guide to what is Prepaid Insurance? Here we discuss whether prepaid insurance is an asset along with practical examples, journal entries when it is due, and paid. You may learn more about accounting from the following articles –