Month: October 2021

In January, the company records a journal entry to recognize 1/12 of the value of the insurance policy. The journal entry debits an insurance expense account and credits prepaid expenses for $1,500. At the end of January, the prepaid expense account balance is $16,500 on the balance sheet. The January month-end income statement reports $1,500 as the prepaid insurance example current period insurance expense. Every month, the journal entry further decreases the prepaid expense account balance as the value of the coverage period is recognized by the business. Prepaid expenses are considered current assets because they are amounts paid in advance by a business in exchange for goods or services to be delivered in the future.

• This enables the most accurate reflection of assets in the short term, as well as profit.
• As the business enjoys the use of its rental location, it recognizes the benefit by decreasing the prepaid expense account.
• Prepaid insurance is payments made to insurers in advance for insurance coverage.
• To help maintain the accuracy of financial statements, despite any prepaid expenses on the balance sheet, let’s take a look at how automation solutions can help.
• She is a graduate of Bryn Mawr College (A.B., history) and has an MFA in creative nonfiction from Bennington College.
• Companies pay their insurance before the insurance term begins.

To recognize prepaid expenses that become actual expenses, use adjusting entries. Prepaying your insurance premium might complicate the cancellation process. For example, if you https://www.bookstime.com/ pay your $1,500 annual home insurance premium in one payment, then sell your house six months into the policy’s term, the insurer will have to refund the unused premium.

Can a Small Business Get a Tax Refund?

The adjusting journal entry is done each month, and at the end of the year, when the insurance policy has no future economic benefits, the prepaid insurance balance would be 0. 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. When an asset is expected to be consumed or used in the company’s regular business operations within the accounting year, it is recorded as a current asset. Current assets, sometimes also referred to as current accounts, are shown on the company’s balance sheet. DrPrepaid insuranceCrCash or bankAs time goes by, the prepaid insurance expires. During this period, companies must transfer the expired portion of the premium to the income statement.

As you can see, the prepaid concept follows thematching principleby waiting to recognize the expenses until the period when they benefit the company. This concept is also consistent with theaccrual basis of accountingwhere income and expenses are recorded in the period in which they are incurred—not necessarily the period in which they are paid.

Prepaid Expenses definition

Credit the corresponding account you used to make the payment, like a Cash or Checking account. Crediting the account decreases your Cash or Checking account.