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Prepaid Insurance Journal Entry Example

The adjusting entry is made when the goods or services are actually consumed, which recognizes the expense and the consumption of the asset. The adjusting journal entry is done each month, and at the end of the year, when the lease agreement has no future economic benefits, the prepaid rent balance would be 0. The adjusting entry for taxes updates the Prepaid Taxes and Taxes Expense balances to reflect what you really have at the end of the month.

Prepaid expenses are payments made in advance for goods or services that will be received or used in the future. Notice that the amount for which adjustment is made differs under two methods, but the final amounts are the same, i.e., an insurance expense of $450 and prepaid insurance of $1,350. At the end of each month, an adjusting entry of $400 will be recorded to debit Insurance Expense and credit Prepaid Insurance. Of the total six-month insurance amounting to $6,000 ($1,000 per month), the insurance for 4 months has already expired. In the entry above, we are actually transferring $4,000 from the asset to the expense account (i.e., from Prepaid Insurance to Insurance Expense). Repeat the process each month until the policy is used and the asset account is empty.

  • Since the policy lasts one year, divide the total cost of $1,800 by 12.
  • At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content.
  • There are also many non-cash items in accrual accounting for which the value cannot be precisely determined by the cash earned or paid, and estimates need to be made.

Whereas, in the company’s balance statement, the closing balance of the current prepaid insurance account will show a balance of $7,500 ($10,000- $2,500) for the quarter ending. Prepaid insurance is an asset account on the balance sheet, in which its normal balance is on the debit side. The company should not record the advance payment as the insurance expense immediately. This is due to, under the accrual basis of accounting, the expense should only be recorded when it occurs. At the end of the month, before the books are closed for the month, make one double entry to the journal. If the premium were $1,200 per year, you would enter a credit of $100 to the prepaid insurance asset account, decreasing its value.

Rather, they are classified as current assets, readily available for use when the company needs them. To recognize prepaid expenses that become actual expenses, use adjusting entries. The process of recording prepaid expenses only takes place in accrual accounting.

Prepaid Expenses

This unexpired cost is reported in the current asset account Prepaid Insurance. Unlike conventional expenses, the business will receive something of value from the prepaid expense over the course of several accounting periods. The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash. When the asset is charged to expense, the journal entry is to debit the insurance expense account and credit the prepaid insurance account. Regardless of whether it’s insurance, rent, utilities, or any other expense that’s paid in advance, it should be recorded in the appropriate prepaid asset account.

A prepaid expense is a type of asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Prepaid expenses are initially recorded as assets, but their value is expensed over time onto the income statement. This is usually done at the end of each accounting period through an adjusting entry. As time passes, you decrease the prepaid insurance account and record insurance expense. For example, let’s say your company pays $2,400 for a 1-year insurance policy upfront. Most prepaid expenses appear on the balance sheet as a current asset unless the expense is not to be incurred until after 12 months, which is rare.

  • On the other hand, liabilities, equity, and revenue are increased by credits and decreased by debits.
  • If the company would like to continue to occupy the rental property, it will have to prepay again.
  • The ending balance in Depreciation Expense – Equipment will be closed at the end of the current accounting period and this account will begin the next accounting year with a balance of $0.
  • It identifies the part of accounts receivable that the company does not expect to be able to collect.
  • Prepaid insurance is considered a business asset, and is listed as an asset account on the left side of the balance sheet.
  • Therefore the balance in Accounts Receivable might be approximately the amount of one month’s sales, if the company allows customers to pay their invoices in 30 days.

If the premium were $1,200 per year, for instance, you would record the check for $1,200 as a credit to the cash account in your journal, decreasing the value of that account. Then you would enter a debit of $1,200 to the prepaid insurance asset account, increasing its value. Each month, you will need to move the used portion of the insurance payment to an expense account. The adjusting journal entry for a prepaid expense, however, does affect both a company’s income statement and balance sheet. The adjusting entry on January 31 would result in an expense of $10,000 (rent expense) and a decrease in assets of $10,000 (prepaid rent).

Types of Adjusting Journal Entries

After further review, it is learned that $3,000 of work has been performed (and therefore has been earned) as of December 31 but won’t be billed until January 10. Because this $3,000 was earned in December, it must be entered and reported on the financial statements for December. An adjusting entry dated December 31 is prepared in order to get this information onto the December financial statements. 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.

Which of these is most important for your financial advisor to have?

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. Note that the ending balance in the asset Prepaid Insurance is now $600—the correct amount of insurance that has been paid in advance. Prepaid insurance appears in a company’s statement of financial position in the current asset segment as part of the prepaid expenses. As the insurance gets used up, an adjusting entry for prepaid insurance is made to account for the reduction in assets and the resultant increase in expenses. This increase in expenses reflects in the company’s income statement within the accounting period when it has been used up.

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. 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. For deferred revenue, the cash received is usually reported with an unearned revenue account. Unearned revenue is a liability created to record the goods or services owed to customers. When the goods or services are actually delivered at a later time, the revenue is recognized and the liability account can be removed.

Supplies – Deferred Expense

The adjusting entry ensures that the amount of rent expired appears as a business expense on the income statement, not as an asset on the balance sheet. The adjusting entry ensures that the amount of insurance expired appears as a business expense on the income statement, not as an asset on the balance sheet. The first journal entry is a general one; the journal entry that updates an account in this original transaction is an adjusting entry made before preparing financial statements. Prepaid insurance can be paid monthly, quarterly, or yearly depending on the insurance plan and policies as well as the company’s preference. The prepayment will hence, provide insurance coverage for the company within the period covered by the prepayment. Generally, companies make prepayments for insurance for buildings, equipment, machinery, vehicles, and other valuable items.

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All 12 months from Jan’20 to Dec’20 will be charged in each period against the prepaid expense account to reduce the prepaid account to zero by end of the year. On June 1st, 2020, you will make the following journal entry to reflect this advance payment for insurance. Organizations typically use a prepaid expense ledger to monitor the total amount of money spent on prepayments, when payments are due, and when they will be received. This helps ensure that companies are accurately accounting for their assets while also staying up-to-date with any upcoming liabilities.

These adjusting entries are necessary because they have a direct impact on the company’s financial statements which get issued either monthly, quarterly, or yearly. They are also known as unexpired expenses or expenses paid in advance. It is important to show prepaid expenses journal entry in the financial statements to avoid understatement of earnings. Assume that a company’s only prepaid expense is the prepaid premiums on its liability insurance policy. Also assume that on December 1, the company paid $6,000 for the insurance coverage from December 1 through May 31. The company recorded the December 1 payment with a debit of $6,000 to Prepaid Insurance and a credit of $6,000 to Cash.

If we subtract this amount from the initial payment for the whole year, we should get a $696 balance on the Prepaid Insurance account. It turns out that you have forgotten to make adjusting entries for the past two months. The company can record the prepaid insurance with the journal entry of debiting the prepaid insurance account and crediting the cash account.

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. Likewise, the adjusting entry at the end of the period is necessary for the company to recognize the cost that expires through the passage of time. Rather, they provide value over time; generally over multiple accounting periods. The reason is that the expense expires as you use it, thus, you can’t expense the entire value of the prepaid service immediately.

So when making a journal entry for prepaid insurance, you record the prepaid expense in your business financial records and adjust entries as you use up the service. 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. Prepaid insurance is considered a business asset, and is listed capital lease vs operating lease differences + examples 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. Prepaid insurance is usually considered a current asset, as it will be converted to cash or used within a fairly short time.

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