The balance on the insurance expense account is 5,400, the full cost for the eighteen month period of the policy. 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 practice, payments for prepaid expenses are usually made directly to the expense account. Then, at the end of the year or quarter, an analysis is done to determine if any prepaid expenses exist.
- The balance on the insurance expense account is 5,400, the full cost for the eighteen month period of the policy.
- The articles and research support materials available on this site are educational and are not intended to be investment or tax advice.
- By making this journal entry, the company will be able to record the insurance expense which has been incurred already and the part of prepaid insurance which has now already expired.
- On December 31, a journal entry is required to expense the portion of the insurance policy that has been used from October 1 through December 31—or 25%.
- The prepaid insurance will be recorded when the company makes payment to the insurance company.
- Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping.
Prepaid Expense Journal Entries
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. At the end of the year, there may be expenses whose benefits have been received but not paid for and expenses that may have been paid, but their benefit will appear in the next financial year. Prepaid accounting results from one of the fundamental accounting principles, the matching or accruals concept which sets out that expenses are matched to revenues. On December 31, a journal entry is required to expense the portion of the insurance policy that has been used from October 1 through December 31—or 25%.
Prepaid Expenses
For example, the following journal entry shows an initial payment of $12,000 for one year of insurance, which is recorded as an asset. A business buys one year of general liability insurance in advance, for $12,000. The initial entry is a debit of $12,000 to the prepaid insurance (asset) account, and a credit of $12,000 to the cash (asset) 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.
How much are you saving for retirement each month?
The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. 11 Financial may only transact business in those states in which it is registered, or bookkeeping and payroll services qualifies for an exemption or exclusion from registration requirements.
What are the adjusting entries for prepaid insurance? (Example and Explanation)
- For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing.
- Prepaid expenses are recorded as an asset on a company’s balance sheet because they represent future economic benefits.
- 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 debit entry to insurance expense will result in adding the expenses whereas credit to the prepaid expense account will result in decreasing the current asset.
On the other hand, you would record a prepaid expense when the payment is made in advance for goods or services that will benefit the company in future periods. The advantage of this method is to avoid making unnecessary journal entries for expenses prepaid and utilized within the bookkeeping same accounting period. For example, there is no point in recording prepaid rent for a rent payment made at the beginning of the month but then utilized during the month—unless you issue financial statements in the middle of the month.
- As the prepaid items are consumed, they are gradually recognized as expenses on the income statement through adjusting journal entries.
- The effect of the two entries combined is to show the insurance expense of $2,500 and the balance in prepaid insurance of $7,500.
- When the company makes an advance payment for insurance, it can make prepaid insurance journal entry by debiting prepaid insurance account and crediting cash account.
- Prepaid or unexpired expenses can be recorded under two methods – asset method and expense method.
- When prepaid expenses are recognized, they result in lower net income than cash flow.
- On October 1, the entire insurance payment should be recorded as insurance expense.
- 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.
At the end of each month, the company usually make the adjusting entry for insurance expense to recognize the cost of that has expired during the period. The company usually purchases insurance to protect itself from unforeseen incidents such as fire or theft. And the company is usually required to pay an insurance fees for one year or more in advance. In this case, it needs to account for prepaid insurance by properly making journal entries in order to avoid errors that could lead to misstatement on both balance sheet and income statement.
Businesses can manage prepaid expenses effectively by accurately recording transactions, monitoring the consumption of prepaid items, making timely adjustments, and implementing proper internal controls and procedures. The prepaid insurance expense account under the current assets in the balance sheet will still show the amount of $16,000. In each of the successive months, equal parts insurance will continue to be credited from the prepaid insurance account.
