This means that the premium you pay is allotted to the upcoming time period. Prepaid insurance is a significant expense for many businesses, and it often involves substantial amounts of money. Therefore, companies must ensure that they record these transactions properly, accurately reflect their financial position, and comply with accounting principles and standards. In this section, we will discuss how to record prepaid insurance transactions in the journal and ledger accounts.

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• Let’s assume that a company is started on December 1 and arranges for business insurance to begin on December 1.
• For recording transactions relating to prepaid insurance, it is necessary to understand how to create journal entries and adjust prepaid insurance accounts to reveal the correct balance.
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• The spreadsheet would continue through December, displaying the amount that will need to be expensed each month.

Banking services are provided by Choice Financial Group and Metropolitan Commercial Bank, Members FDIC. Insurance is not for the investor in you but the individual and family man in you. Insurance protects your dependents and your assets (non-financial) from uncertainty. Insurance is a contractual agreement under which the insured party promises to pay the insurer a periodic amount in exchange for a payout in the event of a future loss. You can set the default content filter to expand search across territories. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.

Why is expense a debit?

Prepaid insurance is becoming more and more popular, as people want the convenience of not having to carry a policy around with them. The answer to this question largely depends on your financial institution and how they classify prepaid insurance products. If your bank classifies prepaid insurance as a deposit account, then it will be treated as a type of credit.

• Whatever the cause of the credit balance in the prepaid insurance account, the account needs to be switched to a liability or zeroed out by making payment before issuing a balance sheet.
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To help you find the best one for your family, we analyzed and ranked 32 kids’ debit cards. After all debits and credits are posted to the general ledger, the Prepaid Insurance account will have a debit balance of $550 reflecting the cost of insurance policy that has not expired. On the other hand, the Insurance Expense account will have a debit balance of $50 reflecting the expired portion of the insurance policy during January. According to the debit-credit rule, the increase in assets is debited.

Why Your Prepaid Debit Card Needs FDIC Insurance

A business buys one year of general liability insurance in advance, for $12,000. 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. Insurance providers prefer to bill insurance in advance and so knowing the right journal entry for prepaid insurance is very important.

Why Is Prepaid Insurance Important?

Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. For example, because of recent legal issues, Jill puts her attorney on retainer. Though she pays the retainer in full, Jill still needs to determine how much she will need to expense each month as the retainer is used.

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In summary, prepaid insurance is an advance payment made by a company for insurance coverage for a specific period. It is considered an asset on a company’s balance sheet until the coverage period elapses, where it is then recognized as an expense. It is important for businesses to have insurance coverage as it helps to protect them against unforeseen events. Proper accounting of prepaid insurance helps to ensure that a company’s financial statements accurately reflect its true financial position. One objective of the adjusting entry is to match the proper amount of insurance expense to the period indicated on the income statement. Around 5.9 million American households don’t have a bank account, and an additional 18.7 million households have limited access to financial services.

Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. First, Jill will need to record the initial payment to her attorney for $3,000. If you’re creating a spreadsheet to track your monthly expense, it would look like this.

To recognize the expense, the accountant will debit the insurance expense account and credit the prepaid insurance account. This means that the asset account is reduced and the expense account is increased. When January comes around, you would then debit $2,000 as rent expense for January and credit your prepaid rent expense account for $2,000, move from excel to accounting software leaving you with a balance of $22,000. The $2,000 you expensed for January’s rent appears on your income statement as rent expense, while your prepaid rent asset account is reduced by $2,000 on your balance sheet. At the end of the year, you will have expensed the entire $24,000, and your prepaid rent account will have a $0 balance.

This same adjusting entry will be prepared at the end of each of the next 11 months. 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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Remember, to track prepaid expenses properly, they need to be recorded in your general ledger as a prepaid expense asset, with a portion of the prepaid asset accounted for each month as an expense. You can do a lot with prepaid debit cards and online payments apps, but a bank account may actually work out to be cheaper and more secure. 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. On November 20, the payment is entered with a debit of $2,400 to Prepaid Insurance and a credit of $2,400 to Cash. Reach out to your medical provider to see if it’s possible to create a payment plan that works for you.

These are both asset accounts and do not increase or decrease a company’s balance sheet. Recall that prepaid expenses are considered an asset because they provide future economic benefits to the company. Prepaid expenses aren’t included in the income statement per generally accepted accounting principles (GAAP). Thus, prepaid expenses aren’t recognized on the income statement when paid because they have yet to be incurred. Suppose there are additional insurance expenses, say on business vehicles, that have both liability and physical damage coverage for 3 years, totaling $6,000. – The cash account would be debited for $1,200, reflecting the fact that the business owner paid money out of their cash account to pay for the insurance premium.