Want to learn more about prepaid insurance to determine if it’s right for you? The most important calculation regarding prepaid insurance reflects the unexpired portion of the policy. Companies come to BlackLine because their traditional manual accounting processes are not sustainable. We help them move to modern accounting by unifying their data and processes, automating repetitive work, and driving accountability through visibility.
Prepaid expenses are expenses that will occur in the future but are paid for upfront. The most common prepaid expense examples are rent and insurance. At the end of each month, an adjusting entry of $400 will be recorded to debit Insurance Expense and credit Prepaid Insurance.
A prepaid expense is an expenditure that a business or individual pays for before using it. The adjusting journal entry for a prepaid expense, however, does affect both a company’s income statement and balance sheet. The adjusting entry on January 31 would result in an expense of $10,000 (rent expense) and a decrease in assets of $10,000 (prepaid rent). As the amount of prepaid insurance expires, the expired portion is moved from the current asset account Prepaid Insurance to the income statement account Insurance Expense. This is usually done at the end of each accounting period through an adjusting entry. The company must continue to make appropriate journal entries to apportion the prepaid insurance expense according to the time period during which the expense will continue to accrue.
This adjusting entry is necessary for the company to not overstate its total assets as well as to not understate its total expenses during the period. The journal entries above shows how insurance expense is treated, in case of prepayments. Insurance expense, as an expense is treated in the same way as other expenses that are incurred. Similarly, the treatment of prepaid (as well as accrued) insurance is also similar to that of prepaid (and accrued) expenses. However, during normal course of the business, insurance is generally a prepaid expense, because it is paid in advance, in most cases.
But if a prepaid expense is not consumed within the year after payment, it becomes along-term asset, which is not a very common occurrence. The payment of the insurance expense is similar to money in the bank—as thatmoney is used up, it iswithdrawn from the account ineach month oraccounting period. But if a prepaid expense is not consumed within the year after payment, it becomes a long-term asset, which is not a very common occurrence.
Here’s how an insurance company accounts for prepaid insurance. As mentioned above, the premiums or payment is recorded in oneaccounting period, but the contract isn’t in effect until a future period. A prepaid expense is carried on an insurance company’s balance sheetas acurrent assetuntil it is consumed. That’s becausemost prepaid assets are consumed within a few months of being recorded.
Prepaid insurance is commonly recorded, because insurance providers prefer to bill insurance in advance. If a business were to pay late, it would be at risk of having its insurance coverage terminated. To illustrate prepaid insurance, let’s assume that on November 20 a company pays an insurance premium of $2,400 for insurance protection during the six-month period of December 1 through May 31. On November 20, the payment is entered with a debit of $2,400 to Prepaid Insurance and a credit of $2,400 to Cash. Likewise, the company can make insurance expense journal entry by debiting insurance expense account and crediting prepaid insurance account.
The full value of the prepaid insurance is recorded as a debit to the asset account and as a credit to the cash account. Each month, as a portion of the prepaid premiums are applied, an adjusting journal entry is made as a credit to the asset account and as a debit to the insurance expense account. Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract. When the asset is charged to expense, the journal entry is to debit the insurance expense account and credit the prepaid insurance account. Thus, the amount charged to expense in an accounting period is only the amount of the prepaid insurance asset ratably assigned to that period. Prepaid insurance is usually considered a current asset, as it becomes converted to cash or used within a fairly short time.
Prepaid expenses are not recorded on an income statement initially. Instead, prepaid expenses are first recorded on the balance sheet; then, as the benefit of the prepaid expense is realized, or as the expense is incurred, it is recognized on the income statement. Technically, we can argue that prepaid insurance counts as an asset for individuals too. I get a slight discount from my insurance company doing it this way, as opposed to paying monthly.
Bank in connection with its administration of prepaid debit cards that held unemployment insurance benefits. Bank has offered prepaid debit cards to eligible consumers in at least 19 states and the District of Columbia to distribute unemployment insurance benefits through its ReliaCard https://personal-accounting.org/prepaid-insurance-definition/ program. Bank implemented new freeze criteria to determine whether to freeze a card due to suspected fraud. Using these new fraud controls and its expanded criteria used for freezing accounts, U.S. Bank froze the accounts of tens of thousands of cardholders eligible for benefits.
Unless an insurance claim is filed, prepaid insurance is usually renewable by the policyholder shortly before the expiry date on the same terms and conditions as the original insurance contract. However, the premiums may be marginally higher to account for inflation and other operating factors. As mentioned earlier, recording prepaid insurance does hold tantamount importance from an organizational perspective. This is primarily because of the fact that business are supposed to follow accrual basis of accounting. During this period, prepaid insurance of $5,000 from the previous period expired.