This is because the company owes its insurer for the insurance coverage that has not yet been provided and that will be provided in the future. 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.
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- Payment is a current asset until your company begins using the office space or facility for the time you paid it.
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- To adjust this, the accountant will need to debit the refund amount to the prepaid insurance account by crediting the insurance expense.
Improve the prioritization of customer calls, reduce days sales outstanding, and watch productivity rise with more dynamic, accurate, and smarter collection management processes. The matching principle is the basis for allocating expenses to the periods in which they are used or consumed. It requires that expenses be matched with the revenues they help generate. In this case, assuming that the service represented by the asset expires equally each month, the Prepaid Insurance account must be reduced by $900.
#1. Is prepaid insurance a long-term asset?
When the insurance premium payment is ordinarily due, that expense is deducted from the asset side and moved to the expense side. The entire cost of prepaid insurance is recorded on the asset side and is then amortized over the policy term. It’s only insurance companies, with the need to have pristine financial statements, that need to make sure every dollar is accounted for. For these businesses, any unused insurance that’s been received but haven’t expired count as an asset. Prepaid insurance is an advance payment made by individuals or corporate organizations to insurance companies for various insurance coverage. Since this payment is usually made in advance, it is an asset to the individual or corporate organization that made the payment.
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- A common financial question we see asked is related to prepaid insurance.
- Throughout July, the entire $1,800 is classified as prepaid insurance.
- Common prepaid expenses of a company include prepaid rent, prepaid utility expenses, and prepaid insurance coverage.
- Through the amortization process, the prepaid coverage is expensed appropriately across financial reporting periods.
An asset can be generally classified as either a current or non-current asset. Current assets are generally considered very liquid because they can be easily converted to cash; usually in less than 12 months. Non-current assets are long-term assets such as land which generally require over one year before they can be converted to cash. For instance, an insurance company might offer a 10% or 5% discount to clients who pay for a year or six months subscription. The lump sum payment serves as a means of increasing the working capital of the insurance company and a strategy for customer retention. Furthermore, some insurance companies may charge a cancellation fee when a client chooses to cancel their subscription and discontinue using the insurance company’s services.
What is prepaid insurance?
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What Is Prepaid Insurance and Is It an Asset?
As the insurance coverage period progresses and a portion of the prepaid insurance is utilized, an adjusting entry is required. In this case, the company debits the “Insurance Expense” account and credits the “Prepaid Insurance” account. This adjustment recognizes the reduction in the prepaid insurance value (asset) and increases the insurance expense (expense category) on the income statement. Prepaid insurance is considered a current asset and refers to paying your insurance premiums in advance in a lump sum.
Why Is Prepaid Insurance Considered a Debit in the Asset Account?
Companies that have experienced an accident on the item insured can file an insurance claim. Additionally, they may cancel their subscription and discontinue the insurance contract. Rarely, an insurance policy will extend coverage beyond the 12-month accounting period following payment of the initial premium. In such a case, the portion of insurance prepaid in the prior year and used in the following year is a long-term asset. During this period, companies must transfer the expired portion of the premium to the income statement. The journal entry for this aspect of prepaid insurance is as follows.
It is a current asset because the value of prepaid insurance will be used within a year, and usually companies prepay their insurance expenses for a year. Not only prepaid insurance but all other prepaid expenses are identified as current assets because they will be used or received in less than a year. Prepaid insurance is considered an asset because it generates future economic value for the business.
Prepaid insurance is considered an asset because it represents a prepayment for an expense that will benefit the company in the future. When a business pays for insurance coverage in advance, it’s essentially buying future protection against potential risks and losses. Since the prepaid insurance has not yet expired, its value remains intact and can be utilized in the event of an insurance claim. Therefore, on the balance sheet, it is classified as a current asset, reflecting the company’s financial resources that can be tapped into for future security. As time passes and the insurance coverage period elapses, the prepaid insurance gradually converts into an expense, reducing the asset value on the balance sheet and reflecting the cost incurred over time. It falls under the category of prepaid expenses, where payments are made in advance for services or coverage that will be utilized in the future.
Firstly, this classification enables businesses to alleviate the burden of monthly premium payments, thereby curbing immediate financial outflows and effectively reducing operational costs. Prepaid insurance is considered a business asset, and is listed as an asset account on the left side of the balance sheet. The payment of the insurance expense is similar to money in the bank, and the money will be withdrawn from the account as the insurance is “used up” each month or each accounting period.
Should a business opt to terminate a policy prior to its coverage period’s expiration, the unredeemed portion of prepaid premiums can be reclaimed, effectively leading to a refund or credit. This mechanism can inject a supplementary source of cash into the business, augmenting financial flexibility and resilience. Occasionally, an insurance policy will extend coverage beyond the original 12-month accounting term following the initial premium payment. Prepaid insurance is a long-term asset if used next year and not the year you purchased it. The Importance of Understanding Prepaid Insurance in Accounting
Accounting and finance professionals need to understand the concept of prepaid insurance fully.
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In this way, the asset value of the prepaid insurance will be reduced to zero at the end of the time period which was paid for in advance. Similarly, the expense will reach the total of the prepaid amount at the end of that same period. In exchange, the insurance company usually offers the customer a discount on the premium price, so the business saves money on the policy. Whether you’re shareholders equity definition equation ratios examples new to F&A or an experienced professional, sometimes you need a refresher on common finance and accounting terms and their definitions. BlackLine’s glossary provides descriptions for industry words and phrases, answers to frequently asked questions, and links to additional resources. Timely, reliable data is critical for decision-making and reporting throughout the M&A lifecycle.
The bookkeeper would create an initial journal entry that debits the lump-sum amount to the asset account for prepaid insurance and a credit of the same amount from the asset account for cash. This lump-sum amount is then amortized into smaller payments depending on the policy’s original payment frequency, which is recorded on the business’s income statement. Depending on the policy, a business may pay their insurance premiums on a monthly, quarterly, or annual basis. When the business pays for the premiums upfront, they are paying in advance for the entire policy period. Therefore, the entire prepaid insurance expense is recorded on the “asset” side of the balance sheet.
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Due to its nature, people may wonder whether prepaid insurance is an asset or an expense. Essentially, it occurs due to the insurance premium paid by companies. However, due to the nature of this transaction, companies cannot classify it as such. The primary reason companies must classify this insurance as prepaid is that it relates to the unexpired portion. This allocates that month’s portion of the insurance expense, drawing down the prepaid asset amount.
On the balance sheet, it would list prepaid insurance as a current asset with a value of $12,000. After six months, the company has used up $6,000 worth of insurance coverage, so it would list $6,000 as an 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.