Understanding Prepaid Insurance Journal Entries: A Step-by-Step Tutorial

For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. Suppose at the end of the month, 60% of the supplies have been used. Thus, out of the $1,500, $900 worth of supplies have been used and $600 remain unused. The $900 must then be recognized as expense since it has already been used. The first portion, comprising received benefits, is an expense. A business license is a right to do business in a particular jurisdiction and is considered a tax.

Prepaid Expenses FAQs

• Prepaid expenses are considered assets because they represent future economic benefits that the company will receive.
• In this tutorial, we will delve into the concept of prepaid insurance, its journal entries, and work through examples to solidify your understanding.
• The rent expense, in this case, should be $4,000 and what is it currently?
• Prepaid insurance is an asset account on the balance sheet, in which its normal balance is on the debit side.
• The Accumulated Depreciation account balance is the amount of the asset that is “used up.” The book value is the amount of value remaining on the asset.

On 1 September 2019, Mr. John bought a motor car and got it insured for one year, paying $4,800 as a premium. When he paid this premium, he debited his insurance expenses account with the full amount, i.e., $4,800. 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. This adjusting entry will be repeated at the end of May and June to recognize the insurance expense gradually over the quarter.

Deferred Expenses

• A fixed asset is a tangible/physical item owned by a business that is relatively expensive and has a permanent or long life—more than one year.
• In addition, on your income statement you will show that you did not pay ANY taxes to run the business during the month, when in fact you paid $100.
• By the end of the month some of the insurance expired, so you reduced the value of this asset to reflect what you actually had on hand at the end of the month ($1,100).
• Here are the ledgers that relate to the purchase of supplies when the transaction above is posted.
• Prepaid insurance refers to the amount of insurance premium that has been paid in advance for future coverage.
• 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.

This same adjusting entry will be prepared at the end of each of the next 11 months. 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.

What are the two methods for recording prepaid expenses?

The two accounts involved will be the balance sheet account Allowance adjusting journal entry for prepaid insurance for Doubtful Accounts and the income statement account Bad Debts Expense. A prepaid expense by definition is an expense that has been paid for by the business in advance, that is, before the services for that expense have been availed. In this case, the business must record such expenses as prepaid expenses.

Note that the ending balance in the asset Prepaid Insurance is now $600—the correct amount of insurance that has been paid in advance. The income statement account Insurance Expense has been increased by the $900 adjusting entry. It is assumed that the decrease in the amount prepaid was the amount being used or expiring during the current accounting period. The balance in Insurance Expense starts with a zero balance each year and increases during the year as the account is debited. The balance at the end of the accounting year in the asset Prepaid Insurance will carry over to the next accounting year. Prepaid insurance refers to the amount of insurance premium that has been paid in advance for future coverage.

How long can prepaid expenses be reported as an asset?

The contra asset account which accumulates the amount of Depreciation Expense taken on Equipment since the equipment was acquired. A related account is Insurance Expense, which appears on the income statement. The amount in the Insurance Expense account should report the amount of insurance expense expiring during the period indicated in the heading of the income statement. The credit balance in this account comes from the entry wherein Bad Debts Expense is debited. The amount in this entry may be a percentage of sales or it might be based on an aging analysis of the accounts receivables (also referred to as a percentage of receivables).

11 Financial’s website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links. 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 point is that a business has to select payment options that are reasonable and appropriate for their situations and circumstances and require payments in reasonable increments.

Types and examples of adjusting entries:

This should be the debit balance in Accounts Receivable minus the credit balance in Allowance for Doubtful Accounts. When the allowance account is used, the company is anticipating that some accounts will be uncollectible in Certified Public Accountant advance of knowing the specific account. As a result the bad debts expense is more closely matched to the sale. When a specific account is identified as uncollectible, the Allowance for Doubtful Accounts should be debited and Accounts Receivable should be credited. A visual aid used by accountants to illustrate a journal entry’s effect on the general ledger accounts.

• Because this $3,000 was earned in December, it must be entered and reported on the financial statements for December.
• To transfer what expired, Taxes Expense was debited for the amount used and Prepaid Taxes was credited to reduce the asset by the same amount.
• One of the most common mistakes is making incorrect accounting entries.
• For instance, if a company pays $24,000 for a year’s rent in advance, it initially debits Prepaid Rent and credits Cash.
• After 60 months, the balance in the Accumulated Depreciation account is $6,000 and therefore the equipment is fully depreciated and has no value.
• To conclude what has been explained above, prepaid insurance is a part of the current assets of the business because it has been paid off by the business already for future use.

Adjusting journal entries for prepaid insurance

Rather, they are classified as current assets, readily available for use when the company needs them. 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.

Categorised in: Bookkeeping

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