As the prepaid insurance expires throughout the passage of time, the company needs to transfer the prepaid insurance that has expired in the period to the insurance expense. In the business, the company usually needs to make an advance payment for the insurance that it has purchases. In this case, it is important for the company to record the payment as prepaid insurance. Prepaid insurance policies are commonly used in the business world, particularly by companies that want to manage their risks and protect their assets.
HighRadius Named an IDC MarketScape Leader for the Second Time in a Row For AR
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. In this way, the asset value of the bookkeeping and payroll services 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. Prepaid expenses are expenses that will occur in the future but are paid for upfront.
Definition of Prepaid Insurance
Prepaid insurance is considered a prepaid asset because it benefits future accounting periods. It relieves them of the monthly premium expense, and in doing so, reduces their costs, while at the same time still conferring the benefit of having coverage for the business. When a company pays its insurance payments in advance, it makes a debit entry to its prepaid insurance asset account. As the coverage term progresses and sections of the prepaid insurance are expensed, the prepaid insurance account is credited to reflect the decrease in the prepaid amount. Prepaid insurance for businesses is very valuable in terms of providing financial stability, budgeting accuracy, and risk mitigation. However, to ensure accuracy of financial statements, it is essential that these are recorded in the correct accounting period.
Company Overview
These are payments paid in advance for goods or services that will be received in the future. It provides the benefit of obtaining services at a predetermined cost, which aids in budgeting and financial stability. Among these, one particularly important type of prepaid expense is prepaid insurance. The payment is entered on November 20 with a debit of $2,400 to prepaid insurance and a credit of $2,400 to cash. But if a prepaid expense is not consumed within the year after payment, it becomes a long-term asset, which is not a very common occurrence. The payment of the insurance expense is similar to money in the bank—as that money is used up, it is withdrawn from the account in each month or accounting period.
Any money you spend with a prepaid card is deducted from your card balance, not your bank account. You don’t need a bank account to use prepaid cards, which is why they appeal to people prepaid insurance who are unable to access traditional banking. The insurance used for December will be reported as an Insurance Expense on December’s income statement. Insurance companies often offer incentives to customers who prepay their premiums, but this type of plan requires making a large lump-sum payment.
Where does prepaid insurance go on a balance sheet?
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. The following journal entry will be passed and reflected in the books of accounts of XYZ company. This blog covers the ins and outs of prepaid insurance, its importance, advantages, examples, ways of recording, calculations, and much more.
Explore our full suite of Finance Automation capabilities
In this case, the company’s balance sheet may show corresponding charges recorded as expenses. For most industries, a company’s current assets are defined as cash and other assets that will turn to cash or will be used up or consumed within one year of the balance sheet date. Insurance providers may allow a business to pay multiple monthly premiums in advance, in the form of one lump sum. For the insurance company, it generates more working capital and greater customer retention. Prepaid expenses are expenses that are bought or paid for in advance, and may include things like insurance, rent, utilities, and subscriptions.
Prepaid Insurance: Definition, How It Works, Benefits, And Example
However, individuals can also opt for prepaid insurance to safeguard their personal belongings, homes, or even their lives. While prepayment and monthly petty cash billing are standard ways to pay an insurance premium, some auto insurance companies offer pay-per-mile policies. Prepaying your insurance premium might complicate the cancellation process. For example, if you 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. Although providers do issue prorated refunds, you may have to wait days or weeks to receive the money.
Monthly Financial Reporting Template for CFOs
- Prepaid insurance is first recorded as an asset on the balance sheet because the coverage is for a future point in time.
- The insurance company is legally bound to provide the coverage outlined in your policy during the prepaid period.
- The payment of the insurance expense is similar to money in the bank—as that money is used up, it is withdrawn from the account in each month or accounting period.
- It provides the benefit of obtaining services at a predetermined cost, which aids in budgeting and financial stability.
This unexpired cost is reported in the current asset account Prepaid Insurance. 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.
Leave a Reply