Is Prepaid Insurance An Asset: Accounting Enigma Explained : Insurance Blob

is prepaid insurance an asset

Simply put, prepaid insurance is a payment you make for insurance coverage in advance, typically covering a period longer than one accounting period. It would be entered into the general ledger as a debit of $12,000 to the asset account and a credit for the same amount to the cash account. Then, when the expense is incurred, the prepaid expense account is reduced by the amount of the expense, and the expense is recognized on the company’s income statement in the period when it was incurred. All assets, liabilities, and equity of a company are represented on the balance sheet.

  1. Prepaid insurance is considered a prepaid asset because it benefits future accounting periods.
  2. If I pay for insurance, for example, I simply log the expense as any other bill when I pay it.
  3. Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract.
  4. The leftover ($16,000 in this case) will be counted as prepaid insurance for the insurer.
  5. In this way, the asset value of the prepaid insurance will be reduced to zero at the end of the time period which was paid for in advance.
  6. For the insurance company, it generates more working capital and greater customer retention.

Technically, we can argue that prepaid insurance counts as an asset for individuals too. I get a slight discount from my insurance company doing it this way, as opposed to paying monthly. Technically, I could claim the unused portion when I calculate my net worth. At the end of twelve months, the asset account would show a balance of zero for the insurance premium and a total of $12,000 in the insurance expense account.

Is prepaid insurance an asset? Why?

Thus, the amount charged to expense in an accounting period is only the amount of the prepaid insurance asset ratably assigned to that period. Things change if a business is using the “accrual basis” accounting method. These companies, usually larger corporations, will need to count prepaid expenses (like insurance) as an asset until it’s used up. When the numbers get high enough, you can understand why this matters. A company spending six or seven figures a year on insurance costs will want to count that cash as an asset until it’s actually used.

These expenses are not initially recorded on an income statement. Instead, prepaid expenses are first recorded on the balance sheet. But, as the benefit of the prepaid expense is realized, or as the expense is incurred, it is recognized on the income statement. 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. The payment is entered on November 20 with a debit of $2,400 to prepaid insurance and a credit of $2,400 to cash.

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. As noted how to calculate your debt above, prepaid expenses are payments made for goods and services that a company intends to pay for in advance but will incur sometime in the future. Examples of prepaid expenses include insurance, rent, leases, interest, and taxes.

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While the prepaid amount has not expired, it is treated as an asset, which is supposed to be used or converted to cash over the period of the contract. In case the insurance covers a longer period of time, the portion of the payment is classified as a long-term asset. If the prepaid insurance is not fully used when financial statements are prepared, it is going to be an asset at the payment date.

is prepaid insurance an asset

Interest paid in advance may arise as a company makes a payment ahead of the due date. Meanwhile, some companies pay taxes before they are due, such as an estimated tax payment based on what might come due in the future. Other less common prepaid expenses might include equipment rental or utilities. One of the more common forms of prepaid expenses is insurance, which is usually paid in advance. This means that the premium you pay is allotted to the upcoming time period.

As of November 30, none of the $2,400 has expired and the entire $2,400 will be reported as prepaid insurance. 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 https://www.bookkeeping-reviews.com/rob-stone/ and a credit of $2,400 to Cash. Prepaid insurance is the portion of an insurance premium that has been paid in advance and has not expired as of the date of a company’s balance sheet. This unexpired cost is reported in the current asset account Prepaid Insurance. Prepaid insurance is commonly recorded, because insurance providers prefer to bill insurance in advance.

This means that the debit balance in prepaid insurance on December 31 will be $2,000. This translates to five months of insurance that has not yet expired times $400 per month or five-sixths of the $2,400 insurance premium cost. As the amount of prepaid insurance expires, the expired portion is moved from the current asset account Prepaid Insurance to the income statement account Insurance Expense. This is usually done at the end of each accounting period through an adjusting entry.

The transaction does not affect the company’s liabilities or shareholder’s equity. Prepaid insurance is usually considered a current asset, as it becomes converted to cash or used within a fairly short time. 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. Regardless of whether it’s insurance, rent, utilities, or any other expense that’s paid in advance, it should be recorded in the appropriate prepaid asset account.

Prepaid insurance is important because a business should correctly record all of its transactions and resources to have accurate financial statements. Some insurers prefer that insured parties pay on a prepaid schedule such as auto or medical insurance. This is because it has value and future economic benefit for the company.

How is Prepaid Insurance Recorded in Accounting?

When paying for prepaid insurance, the initial record is a debit to the “Prepaid Insurance” account, a current asset. The business’s records would show four months of insurance policy as a current, prepaid asset. Prepaid insurance also creates other benefits for the business. It is considered a prepaid asset, which is a way to express these benefits in accounting terms.

If a business were to pay late, it would be at risk of having its insurance coverage terminated. You may be wondering why we singled out insurance companies as not having the option to treat the prepaid insurance as revenue right away and move on. That’s because the IRS requires larger corporations to use the accrual basis accounting method. While the qualifications are out of the scope of this article, it’s safe to say that no insurer will ever qualify to use the cash basis accounting method.

As the sole content contributor for TripAdvisor, he has successfully translated intricate insurance details into engaging and comprehensible content. This can lead to significant savings, especially for longer coverage periods.