What is the normal balance of a prepaid insurance account?

Like all financial products, prepaid insurance has both advantages and disadvantages to consider. Insurance companies often offer incentives to customers who prepay their premiums, but this type of plan requires making a large lump-sum payment. Some insurers prefer that insured parties pay on a prepaid schedule such as auto or medical insurance. Insurance becomes an asset when you experience a risk covered in your insurance plan, which activates your coverage, allowing you to make a claim and receive a successful payout. For example, on September 01, 2020, the company ABC Ltd. pays $1,200 for one year of fire insurance which covers from September 01, 2020.

• The amount that has not yet expired should be the balance in Prepaid Insurance.
• At the end of the month, before the books are closed for the month, make one double entry to the journal.
• One of the more common forms of prepaid expenses is insurance, which is usually paid in advance.
• In this case, the company’s balance sheet may show corresponding charges recorded as expenses.

This reflects the depletion of the asset by the amount of one month’s insurance, and it correctly enters the expense on the income statement. 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. When they aren’t used up or expired, these payments show up on an insurance company’s balance sheet. Expenses that are used to make payments for goods or services that will be received in the future are known as prepaid expenses. But, as the benefit of the prepaid expense is realized, or as the expense is incurred, it is recognized on the income statement.

In the subsequent year, when insurance is lapsed, then the amount will be deducted as an expense from the Income Statement. Insurance is not the only expense that must be accounted for over multiple reporting periods. Any salaries earned in one month but paid in the next month must be accounted for in a similar manner so that the expense is accounted for in the month that the pay was earned. Property taxes are often paid every six months, and require the same treatment. A business may collect a prepayment for sales on product that has not been delivered, and these sales must be entered as deferred revenue. As prepaid insurance is an asset that will expire through the passage of time, the cost of expiration will need to be recognized as an expense during the period.

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 recorded as expenses. Prepaid expense is personal account in nature and default normal
balance is debit balance and shown under current asset in asset
side of balance sheet.

Prepaid Insurance Journal Entry

As you move through the year and consume the insurance, your prepayment gets used up. The term “prepaid” means the portion of the insurance premium that has not been used up as at the date of the balance sheet. Likewise, the company can make insurance expense journal entry by debiting insurance expense account and crediting prepaid insurance account. Additional expenses that a company might prepay for include interest and taxes. Interest paid in advance may arise as a company makes a payment ahead of the due date. Meanwhile, some companies pay taxes before they are due, such as an estimated tax payment based on what might come due in the future.

• A prepaid expense is carried on an insurance company’s balance sheet as a current asset until it is consumed.
• On December 31, anadjusting entrywill show a debit insurance expense for $400—the amount that expired or one-sixthof $2,400—and will credit prepaid insurance for $400.
• This is going to be represented as Prepaid Rent under the Current Assets.
• However, after adjusting entry at the end of the period for the insurance expense, the asset account will decrease while the expense account will increase.

For example, you might buy a one-year magazine subscription and receive one magazine per month for 12 months. Prepaid expenses are amounts paid in advance by a business in exchange for goods or services to be delivered in the future. They usually relate to the purchase of something that provides value to the business over the course of multiple accounting periods. Prepaid expenses are expenses that will occur in the future but are paid for upfront. Prepaid insurance refers to premiums for insurance that are paid in advance. A premium is a regular, recurring payment made to a provider for the benefit of having insurance coverage.

Using the Normal Balance

The normal balance of any account is the balance (debit or credit) which you would expect the account have, and is governed by the accounting equation. Prepaid Expenses are found on almost every financial statement across different companies. In this regard, it is essential to ensure that the treatment of prepaid expenses is adequately adhered to so that there are no inconsistencies in preparing financial statements. You must pay prepaid expenses upfront before you receive any type of benefit.

Cash Flow Statement

Hence, it is important to record actual expenses for the year, so that the correct amount of profit is calculated. Prepaid Insurance vs. Insurance Expense The prepaid amount will be reported on the balance sheet after inventory and could part of an item described as prepaid expenses. As the prepaid amount expires, the balance in Prepaid Insurance is reduced by a credit to Prepaid Insurance and a debit to Insurance Expense.

Normal Balance of Accounts

The company records the refund with a debit to Cash and a credit to Prepaid Insurance. At December 31, the balance in Prepaid Insurance will be a credit balance of $120, consisting of the debit of $2,400 on January 1, the 12 monthly credits of $200 each, and the $120 credit on July 1. Prior to issuing the December 31 financial statements, the company must remove the $120 credit balance in Prepaid Insurance by debiting Prepaid Insurance and crediting Insurance Expense. 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 adebitof $2,400 to prepaid insurance and a credit of $2,400 to cash. As of November 30, none of the $2,400 has expired and the entire $2,400 will be reported as prepaid insurance.

Difference between Prepaid Expenses and Other Current Assets

The initial journal entry for a prepaid expense does not affect a company’s financial statements. The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash. The payment is entered on November 20 with a debit of $2,400 to prepaid insurance what small business owners need to know about sales tax and a credit of $2,400 to cash. Assume that a company’s annual premium on its liability insurance policy is $2,400 and is due on the first day of each year. When the $2,400 payment is made on January 1, the company debits Prepaid Insurance and credits Cash.

When someone purchases prepaid insurance, the contract generally covers a period of time in the future. 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. 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.

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.

What Type of Account Is Prepaid Insurance on the Balance Sheet?

Common prepaid expenses may include monthly rent or insurance payments that have been paid in advance. 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. The adjusting journal entry is done each month, and at the end of the year, when the insurance policy has no future economic benefits, the prepaid insurance balance would be 0. When there is a payment that represents a prepayment of an expense, a prepaid account, such as Prepaid Insurance, is debited and the cash account is credited. This records the prepayment as an asset on the company’s balance sheet. As noted above, prepaid expenses are payments made for goods and services that a company intends to pay for in advance but will incur sometime in the future.