Why would Prepaid Insurance have a credit balance?

Due to the typical nature in which certain products and services are sold, the majority of corporations will possess at least one type of prepaid expense. With that, there are three popular examples of prepaid expenses frequently incurred by businesses. The financial activities of an organization are classified into different accounts. In order for the company to have an organize and accurate financial statements, they are named and categorized based on assets, liabilities, equity, revenue, and expenses.

The biggest downside is that you will be deducting cash for other potential uses in the same time period. LegalZoom provides access to independent attorneys and self-service tools. Use of our products and services are governed by our
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Example of Prepaid Expense

Maximize working capital with the only unified platform for collecting cash, providing credit, and understanding cash flow. Transform your accounts receivable processes with intelligent AR automation that delivers value across your business. The trial balance, drawn up on 31 December 2019, assumed that he had no other insurance and his insurance expenses account would show a balance of $4,800. At the end of the year, there may be expenses whose benefits have been received but not paid for and expenses that may have been paid, but their benefit will appear in the next financial year. These are the company’s cash in bank accounts, received but undeposited checks, savings and money market accounts, and liquid investments such as Treasury bills.

Treating prepaid amounts differently from regular income gives anyone reading your income statement or balance sheet a better perspective. 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.

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It would be incorrect to charge the whole $4,800 to 2019’s profit and loss account. ” Accrued expenses are common across all lines of business, so you’ve surely come across them or had to deal with them in your business. The upsides and downsides related to prepaying an expense depend on the situation.

Prepaid expenses also help make sure that you do not miss services/goods such as insurance and supplies when needed. In the coming twelve months, the company recognizes an expense of $2,000/month — which causes the current asset recorded on the balance sheet to decrease by $2,000 per month. The amortisation of prepaid expenses may be particularly difficult for corporations that are still reliant on manual accounting protocols as this creates lots of room for human errors to surface. For instance, if an accountant forgets to document an expense or factor in a prepaid expense that has already been amortised, this may lead to inaccurate financial reporting. Consequently, such mistakes may have a significant impact on the business decisions made as well as the firm’s tax reporting accuracy.

Insuranceopedia Explains Prepaid Insurance Expense

The records will reflect that incurred expense for the period, which will reduce the prepaid asset by that amount. Even though the cost of the asset (expense) has been made already, it isn’t yet an expense in the financial records. They transform into an expense during a later accounting period (when the asset gets used for its value). A company, Red Co., pays an insurance premium of $10,000 through its bank account.

Generally, Prepaid Insurance is a current asset account that has a debit balance. The debit balance indicates the amount that remains prepaid as of the date of the balance sheet. As time passes, the debit balance decreases as adjusting entries credit the account Prepaid Insurance and debit Insurance Expense. This is because the company has paid an expense in advance, which will help to ease the expense later. As the expense is paid beforehand, it is treated as a prepaid expense and recorded accordingly. Yearly accounting of a company is done as per financial year, so it is treated as an asset if insurance expense for the next financial year is already paid this year.

Accounting Steps to Record Prepaid Insurance

Nevertheless, Kolleno is a smart credit control software connecting all of the company’s accounting, communication, and payment systems into a centralised platform to streamline the entire documentation process. As mentioned above, the premiums or payment is recorded in one accounting period, but the contract isn’t in effect until a future period. A prepaid expense is carried on an insurance company’s balance sheet as a current asset until prepaid insurance journal entry it is consumed. That’s because most prepaid assets are consumed within a few months of being recorded. Upon the end of every accounting period, a journal entry will need to be recorded for the expense incurred during that timeframe and in accordance with the amortisation schedule. By doing so, this documents the incurring of the expense during that financial period as well as lower the prepaid asset by the corresponding quantity.

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How are prepaid expenses recorded in the financial statements?

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For example, if a business had purchased six months of insurance and decided to cancel the policy after two months, it could redeem the value of the four remaining unused months of coverage. In other words, it could get a refund of the premiums for those four months. In this way, prepaid insurance has economic value, not unlike an investment in stocks or bonds, that can be redeemed at a later time. Rarely, an insurance policy will extend coverage beyond the 12-month accounting period following payment of the initial premium.

This thereby notes that the prepayment is a type of asset on the firm’s balance sheet. In the meantime, an amortisation schedule corresponding to the actual realisation of the prepaid expenses or the benefits of the prepaid asset will be created as well. After each accounting period, the journal entry is posted that reflects the portion of the expense incurred for that specific period according to the established amortization schedule.

At the end of the asset’s life span, it will zero out (and you won’t have to worry about having made any human errors or having forgotten about a prepaid expense). As you can see, if you have multiple prepaid expenses, then this process could easily become overwhelming to keep track of and maintain properly. Prepaid expenses help you lock in a product or service at the current market price. For example, if you believe fuel prices will go up next month, you may want to prepay for fuel to avoid paying extra when the price rises. Prepaid Expenses refer to payments made in advance for products or services expected to be received on a later date — most often related to utilities, insurance, and rent. Prepaid expenses are essentially prepayments that have been made for a product or service whose value will only be realised in the future.

Understanding Prepaid Expenses: Examples & Journal Entry

Learn why it is such an integral and telling part of a company’s financial picture. In exchange, the insurance company usually offers the customer a discount on the premium price, so the business saves money on the policy. Companies come to BlackLine because their traditional manual accounting processes are not sustainable.

• As soon as coverage begins, a portion of the amount is recorded as expense until each payment is used up and these assets are eventually turned into expenses.
• To illustrate how prepaid insurance works, let’s assume that a company pays an insurance premium of $2,400 on November 20 for the six-month period of December 1 through May 31.
• Unless an insurance claim is filed, prepaid insurance is usually renewable by the policyholder shortly before the expiry date on the same terms and conditions as the original insurance contract.
• In essence, the benefits and drawbacks linked with the prepayment of an expense would be largely dependent on the specific situation.
• You shift $2,400 out of Cash on the balance sheet and report $2,400 as a Prepaid Expense instead.