Prepaid Insurance

Prepaid Insurance is the insurance premium paid by a company in an accounting period that didn’t expire in the same accounting period. Therefore, the unexpired portion of this insurance will be shown as an asset on the company's balance sheet.

It refers to the portion of the outstanding insurance premium paid by the company in advance and is currently not due.

An insurance premium is an amount that an organization pays on behalf of its employees and the policies that a business has rendered. Generally, the insurance premium is paid monthly or quarterly. The expense, unexpired and prepaid, is reported in the books of accounts under current assets. And the expense for that period is shown under the profit and loss statement.

• Prepaid insurance is the insurance premium that businesses pay during an accounting period that did not expire within that business period.
• Accountants view the insurance that businesses prepay as an asset. If companies use the coverage within a year after purchase, prepaid insurance is a current asset.
• There are numerous adjustment entries as well as different types of journal entries for prepaid insurance. It avoids the need for pointless new business transaction entries.
• Companies report prepaid insurance as current assets on their balance sheets because it is not used. As soon as the insurance coverage kicks in, it becomes an expense rather than an asset.

To understand this, let's take an example.

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.

In this case, Prepaid Insurance is classified as current assets on the Balance Sheet, as shown below.

Each month's insurance expense is $1200/12 = $100. So for one month between December 1, 2017, and December 31, 2017, $100 worth of insurance is used up.

Let us look at the balance sheet at the end of one month on December 31, 2017.

Please note that the reporting amount of prepaid insurance on the balance sheet asset is $1200 – $100 = $1100.

The insurance used for December will be reported as an Insurance Expense on December’s income statement. Therefore, it is shown below in the sample income statement.

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.

The following journal entry will be passed and reflected in the books of accounts of XYZ company.

Journal Entry when Prepaid Insurance is paid

• Prepaid Insurance is debited, which indicates the creation of an asset on the balance sheet.
• The bank is credited with an equal amount which balances the rule of accounting (for each credit, there is an equal debit)

Journal Entries when Prepaid Insurance is Due

When insurance is due for each quarter, i.e., $2,000 will be subtracted from the prepaid account and is shown as an expense in the income statement for that reporting quarter.

• The income statement for the quarter ending will show an expense of $2,000 under the line item of Insurance Expense.
• In the balance sheet of XYZ company, the closing balance of the current prepaid account will show a balance of $8,000 ($10,000- $2,000) for the quarter ending as the amount due for the quarter has been expensed for that period.
• The amount due and expensed in this quarter is also known as the period cost as it is the cost to be incurred in this period.
• The process of deduction from the account periodically is often known as Amortization.

Passing adjustment entries to balance the books of accounts is often helpful, preventing one from making an entry for new business transactions. To pass an adjustment entry, one must debit the actual expense and credit the prepaid expense account throughout the amortization. This prepaid account will come to the NIL balance at the end of the accounting period and all the expenses accrued in the income statement.

This article has been a guide to what is Prepaid Insurance? Here we discuss whether prepaid insurance is an asset along with practical examples, journal entries when it is due, and paid. You may learn more about accounting from the following articles –

• Accrued Liabilities Meaning
• Deferred Tax Assets
• Prepaid Expense Examples
• Reinsurance Types