Improper classification of prepaid insurance to inflate assets or delay expense recognition can lead to enforcement actions, including fines and penalties. Publicly traded companies face stricter scrutiny, as securities regulators review financial statements for compliance. Businesses in regulated industries, such as healthcare or financial services, may undergo industry-specific audits to ensure prepaid insurance aligns with regulatory standards.

They are gradually recognized as expenses over time as the benefits or services are consumed. This recognition typically occurs through the process of adjusting journal entries, where a portion of the prepaid expense is moved from the balance sheet to the income statement as an expense. A business buys prepaid insurance journal entry one year of general liability insurance in advance, for $12,000. When the insurance premiums are paid in advance, they are referred to as prepaid. The amount of the insurance premiums that remain prepaid at the end of each accounting period are reported in the current asset account, Prepaid Insurance.

Prepaid Insurance Journal Entries

Insurance is the expense that company purchases from the insurance provider in exchange for the insurance service. The entity needs to pay the insurance fees on a yearly basis in order to receive the insurance cover. The entity needs to pay the insurance fees in advance to the insurance company. The adjusting entry decreases the asset account and records an expense for the amount of benefits that have been used or have expired. 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.

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However, if in case the company pays for more than a year, then the prepaid expense will no longer be a part of the current asset. Regardless, the company must make adjusting entries to record insurance expense matched to each month and transfer it from prepaid insurance to insurance expense account. At the payment date of prepaid insurance, the net effect is zero on the balance sheet; and there is nothing to record in the income statement.

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Proper classification ensures transparency and compliance with accounting regulations. Likewise, the company can make insurance expense journal entry by debiting insurance expense account and crediting prepaid insurance account. Prepaid insurance is the portion of an insurance premium that has been paid in advance and has not expired as of the date of a company’s balance sheet. This unexpired cost is reported in the current asset account Prepaid Insurance. If the business owner pays for their insurance with their own money, then nothing gets entered to the business bookkeeping records.

How long can prepaid expenses be reported as an asset?

Company A signs a prepaid insurance journal entry one-year lease on a warehouse for $10,000 a month. The landlord requires that Company A pays the annual amount ($120,000) upfront at the beginning of the year. Prepaid expenses are initially recorded as assets because the company has paid for goods or services that it will consume in the future. These prepayments represent economic resources that will provide future benefits to the company.

• In plain English, you’re increasing your expenses (debit) and decreasing your asset (credit).
• This placement follows the matching principle, ensuring expenses are recognized in the appropriate reporting period.
• Publicly traded companies must adhere to Securities and Exchange Commission (SEC) regulations, which may require detailed breakdowns of prepaid expenses in quarterly or annual filings.
• Prepaid insurance is an asset account on the balance sheet, in which its normal balance is on the debit side.
• The above journal is only used when the business pays for the owner’s personal insurance out of the business bank account.
• In each successive month for the next twelve months, there should be a journal entry that debits the insurance expense account and credits the prepaid expenses (asset) account.
• Prepaid insurance appears on the balance sheet as a current asset since it represents coverage for future periods.

The company has paid $10,000 of the insurance premium for the entire year at the beginning of the first quarter. This adjusting entry will be repeated at the end of each subsequent month to recognize the insurance expense gradually over the year. Consequently, at the end of the month of January, when the company wants to record the insurance expense for the month, they will need to divide the amount paid ie. $24,000 by 12 months which will give the insurance expense for each month that is $2,000.

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• The result of method 2 is an insurance expense of $2,500 and a prepaid expense of $7,500, which is the exact result of method 1.
• Under accrual accounting, expenses are recognized when incurred rather than when paid.
• Since the insurance covers a year, divide $10,000 by 12 months, giving you an $833 expense each month (we’ll ignore the extra pennies for simplicity’s sake).
• If you use an expense account, the P&L will show a huge loss in one month (from the damage) and then a huge profit in the month that the insurance check is received.
• In an indirect cash flow statement, an increase in prepaid expenses results in a negative cash flow adjustment and vice versa.
• So now that we’ve got a handle on that, you’re probably wondering, what kind of journal entries do we make to record the $100 of insurance we’ve used and the $1,100 of prepaid insurance left?

The premium covers twelve months from 1 September 2019 to 31 August 2020, i.e., four months of 2019 and eight months of 2020. It would be incorrect to charge the whole $4,800 to 2019’s profit and loss account. The matching convention requires allocation of the expenditure between the asset that represents the remaining economic benefits and the expense that represents the benefits used or consumed by the firm. The following journal entry will be passed and reflected in the books of accounts of XYZ company. Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurer. The company sells the policy to the customer and may offer other types of coverage.