Prepaid Insurance

Updated on April 11, 2024

What is Prepaid Insurance?

Prepaid Insurance is the insurance premium paid by a company in an accounting period that didn’t expire in the same accounting period. Therefore, the unexpired portion of this insurance will be shown as an asset on the company’s balance sheet.

It refers to the portion of the outstanding insurance premium paid by the company in advance and is currently not due.

An insurance premium is an amount that an organization pays on behalf of its employees and the policies that a business has rendered. Generally, the insurance premium is paid monthly or quarterly. The expense, unexpired and prepaid, is reported in the books of accounts under under current assetsUnder Current AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more. And the expense for that period is shown under the profit and loss statement.

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Key Takeaways

  • Prepaid insurance is the insurance premium that businesses pay during an accounting period that did not expire within that business period.
  • Accountants view the insurance that businesses prepay as an asset. If companies use the coverage within a year after purchase, prepaid insurance is a current asset.
  • There are numerous adjustment entries as well as different types of journal entries for prepaid insurance. It avoids the need for pointless new business transaction entries.
  • Companies report prepaid insurance as current assets on their balance sheets because it is not used. As soon as the insurance coverage kicks in, it becomes an expense rather than an asset.

Is Prepaid Insurance an Asset?

To understand this, let’s take an example.

FastTrack company buys one-year insurance for its delivery truck and pays $1200 for the same on December 1, 2017. Now that the company has prepaid for services to be used, it is classified as an asset.

In this case, Prepaid Insurance is classified as current assets on the Balance SheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more, as shown below.

Prepaid Insurance - Balance Sheet

Each month’sInsurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe. You can calculate it as a fixed percentage of the sum insured & it is paid at a daily pre-specified period. read more insurance expenseInsurance ExpenseInsurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe. You can calculate it as a fixed percentage of the sum insured & it is paid at a daily pre-specified period. read more is $1200/12 = $100. So for one month between December 1, 2017, and December 31, 2017, $100 worth of insurance is used up.

Let us look at the balance sheet at the end of one month on December 31, 2017.

Please note that the reporting amount of prepaid insurance on the balance sheet asset is $1200 – $100 = $1100.

Prepaid Insurance - Balance Sheet 2

The insurance used for December will be reported as an Insurance Expense on December’s income statement. Therefore, it is shown below in the sample income statement.

Insurance Expense - Income Statement

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Prepaid Insurance Explained in Video

 

Prepaid Insurance Journal Entries

XYZ company needs to pay its employee liability insurance for the fiscal year ending December 31, 2018, which amounted to $10,000. The company has paid $10,000 of the insurance premium for the entire year at the beginning of the first quarter.

The following journal entry will be passed and reflected in the books of accounts of XYZ company.

Journal Entry when Prepaid Insurance is paid

ParticularsDebitCredit
Prepaid Insurance A/c$10,000
To Bank/Cash A/c$10,000

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.

ParticularsDebitCredit
Insurance Expense A/c$2,000
To Prepaid Insurance A/c$2,000

Adjustment entry for Prepaid Expenses

Passing adjustment entries to balance the books of accounts is often helpful, preventing one from making an entry for new business transactionsBusiness TransactionsA business transaction is the exchange of goods or services for cash with third parties (such as customers, vendors, etc.). The goods involved have monetary and tangible economic value, which may be recorded and presented in the company's financial statements.read more. To pass an adjustment entry, one must debit the actual expense and credit the prepaid expense accountPrepaid Expense AccountPrepaid expenses refer to advance payments made by a firm whose benefits are acquired in the future. Payment for the goods is made in the current accounting period, but the delivery is received in the upcoming accounting period.read more throughout the amortization. This prepaid account will come to the NIL balance at the end of the accounting period and all the expenses accruedExpenses AccruedAn accrued expense is the expenses which is incurred by the company over one accounting period but not paid in the same accounting period. In the books of accounts it is recorded in a way that the expense account is debited and the accrued expense account is credited.read more in the income statement.

Frequently Asked Questions (FAQs)

What are the main advantages of prepaid insurance?

The main advantage of prepaid insurance is that companies occasionally pay bills in advance to gain a discount. A business may gain from prepaid expenses by avoiding the need to make payments for upcoming accounting periods.

Are prepaid insurance a current assets?

Because they represent a future benefit owed to the company, companies list prepaid expenses first on the balance sheet in the prepaid asset account. Because companies anticipate them to be consumed, employed, or spent through regular business activities within a year. So accountants regard prepaid expenses as current assets.

What are some prepaid insurance examples?

Prepaid expenses include rent deposits, insurance premiums, and retainers for attorneys.

Is prepaid insurance a debit or credit?

Generally, Prepaid Insurance is a current asset account that has a debit balance. The debit balance indicates the amount that remains prepaid as of the date of the balance sheet.

This article 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 –

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