Understanding The Journal Entry For Adjusting Prepaid Insurance

Each month, you will need to move the used portion of the insurance payment to an expense account. 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. A common prepaid expense is the six-month insurance premium that is paid in advance for insurance coverage on a company’s vehicles. The amount paid is often recorded in the current asset account Prepaid Insurance. If the company issues monthly financial statements, its income statement will report Insurance Expense which is one-sixth of the six-month premium.

Adjusting Entry for Prepaid Insurance

The insurance used for December will be reported as an Insurance Expense on December’s income statement. On December 29, 2022, you prepay $18,000 for a year’s insurance on a delivery truck, covering January to December 2023. You’ve successfully kept your financial statements honest and your accountant happy. Thus, out of the $1,500, $900 adjusting entries for prepaid insurance worth of supplies have been used and $600 remain unused. Expenses are considered incurred when they are used, consumed, utilized or has expired.

Is prepaid rent debit or credit?

Similarly, a prepaid insurance expense is a prepaid expense that has been paid for by the company. Prepaid insurance is essentially a part of the insurance premium or a fee that is paid by the company in advance as a part of the insurance agreement for an extended period of time. By making this journal entry, the company will be able to record the insurance expense that has been incurred already and the part of prepaid insurance that has now expired. When a company prepays for an expense, it is initially recognised as a prepaid asset on the balance sheet.

How do you account for prepaid expenses in adjusting journal entries?

Then you would enter a debit to the insurance expense account, increasing the value of the expenses. Adjusting entries are necessary because, without them, a company’s income and expenses won’t match up correctly, and financial statements will be inaccurate. A prepaid expense can be recorded initially as an expense or as a current asset. The current month’s insurance expense of $1,000 ($6,000/6 months) is reported on each month’s income statement. The unexpired amount of the prepaid insurance is reported on the balance sheet as of the last day of each month. Prepaid insurance is treated as an asset because it has been paid for by the company and has future value.

This is done to balance the books of accounts and prevent the need for pointless new business transaction entries. In this guide, we’ll dive into the nitty-gritty of adjusting entries for prepaid insurance. We’ll keep it real, toss in a dash of humor, and by the end, you’ll understand why these adjustments are essential for your financial statements—not just some accounting mumbo jumbo.

Prepaid insurance is charged to expense on a straight-line basis

$24,000 by 12 months which will give the insurance expense for each month that is $2,000. XYZ company needs to pay its employee liability insurance for the fiscal year ending December 31, 2018, which amounted to $10,000. The company has paid $10,000 of the insurance premium for the entire year at the beginning of the first quarter. In this case, Prepaid Insurance is classified as current assets on the Balance Sheet, as shown below. FastTrack company buys one-year insurance for its delivery truck and pays $1200 for the same on December 1, 2017. Now that the company has prepaid for services to be used, it is classified as an asset.

Transitioning From Prepaid to Expense

Now, you might be thinking, “Can’t I just forget about adjusting entries and call it a day? Adjusting entries for prepaid insurance are crucial because they ensure your financial records reflect reality. By making this journal entry, the company will be able to record the insurance expense which has been incurred already and the part of prepaid insurance which has now already expired. Likewise, the net effect of the prepaid insurance journal entry in this example is zero on the balance sheet. The company usually purchases insurance to protect itself from unforeseen incidents such as fire or theft.

• If a business were to pay late, it would risk having its insurance coverage terminated.
• The company should not record the advance payment as the insurance expense immediately.
• The amount of the prepaid insurance that has expired is moved from the prepaid insurance asset account to the insurance expense account.
• Documentation, such as the insurance policy and proof of payment, supports the value recorded.

Asset Method

Thus, you record an adjusting journal entry at the end of the first month by debit Insurance Expense for $200 and crediting the Prepaid Insurance account for $200. You would then make this same adjusting journal entry at the end of each month until the policy expires. The $1,500 balance in the asset account Prepaid Insurance is the preliminary balance. If the prepayment covers a longer period, then the portion of the prepaid insurance that will not be charged to expense within one year should be classified as a long-term asset. To illustrate prepaid insurance, let’s assume that on November 20 a company pays an insurance premium of $2,400 for insurance protection during the six-month period of December 1 through May 31.

• Examples include accrued expenses (like wages payable) and accrued revenue (like interest receivable).
• The balance in Accounts Receivable also increases if the sale was on credit (as opposed to a cash sale).
• Therefore the account Accumulated Depreciation – Equipment will need to have an ending balance of $9,000.
• This is due to, under the accrual basis of accounting, the expense should only be recorded when it occurs.

For instance, if a company pays $24,000 for a year’s rent in advance, it initially debits Prepaid Rent and credits Cash. After four months, the company needs to recognize the rent expense for those months. The adjusting entry would debit Rent Expense for $8,000 (4 months x $2,000/month) and credit Prepaid Rent for $8,000. This reduces the prepaid rent asset and recognizes the expense in the correct period, ensuring accurate financial statements. This is done through an adjusting entry, which is usually done at the end of each accounting period.