Adjusting Entry for Prepaid Expense

Therefore, an adjusting entry must be recorded as of December 31 to credit Prepaid Expenses for $1,000 and to debit Insurance Expense for $1,000. For example, assume ABC Company purchases insurance for the upcoming twelve month period. ABC Company will initially book the full $120,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash. You would make this a journal entry just like you would for any other prepaid insurance journal entries. Prepaid insurance is usually categorized as a current asset because the coverage typically expires within one year or the company’s operating cycle. Documentation, such as the insurance policy and proof of payment, supports the value recorded.

• Prepaid Insurance is the insurance premium paid by a company in an accounting period that didn’t expire in the same accounting period.
• Prepaid insurance is considered an asset because it benefits future accounting periods.
• Each month, an adjusting entry will be made to expense $10,000 (1/12 of the prepaid amount) to the income statement through a credit to prepaid insurance and a debit to insurance expense.
• 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.

Example of Adjusting Prepaid Expenses

It is assumed that the decrease in the supplies on hand means that the supplies have been used during the current accounting period. For example, a company might pay rent at the end of the month but occupy the space from the beginning of the adjusting entries for prepaid insurance month. Accruals also include accrued expenses, such as wages paid to an employee, and accrued revenues, such as revenue generated in one accounting period but not recognised until a later period. 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. In this journal entry, the company records the prepaid insurance as an asset since it is an advance payment which the company has not incurred the expense yet.

Prepaid insurance is a current asset

The amount of the prepaid insurance that has expired is moved from the prepaid insurance asset account to the insurance expense account. This is done by debiting the insurance expense account and crediting the prepaid insurance account. For example, a company pays an insurance premium of $2,400 on November 20 for insurance coverage from December 1 to May 31. On November 20, the payment is recorded with a debit of $2,400 to prepaid insurance and a credit of $2,400 to cash. As of November 30, none of the $2,400 has expired and the entire amount is reported as a prepaid insurance asset. On December 31, an adjusting entry is made to recognise that one month of insurance ($400, or 1/6 of $2,400) has expired.

• Thus, out of the $1,500, $900 worth of supplies have been used and $600 remain unused.
• Prepaid insurance is initially recorded as an asset, but its value is expensed over time onto the income statement.
• Note that the ending balance in the asset Prepaid Insurance is now $600—the correct amount of insurance that has been paid in advance.
• Then you would enter a debit of $1,200 to the prepaid insurance asset account, increasing its value.

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

For example, 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. Prepaid expenses are initially recorded as assets because they represent future economic benefits.

The balance sheet would then reflect $8,000 in prepaid rent as an asset, while the income statement would show a rent expense of $4,000 for the four months utilized. This means the company should record the insurance expense at the period end adjusting entry when a portion of prepaid insurance has expired. Prepaid insurance is an asset account on the balance sheet, in which its normal balance is on the debit side. The company should not record the advance payment as the insurance expense immediately.

Adjusting Journal Entries:Prepaid Expenses (Accrual Accounting Method) Video Summary

The following journal entry will be passed and reflected in the books of accounts of XYZ company. By making these adjustments each quarter, you keep your financial statements accurate. Plus, you avoid any awkward conversations with stakeholders who might wonder why your assets are overstated. Discrepancies signal potential errors needing investigation, such as incorrect initial entries, miscalculated adjustments, or unrecorded policy changes like cancellations or refunds.

This is because the expense has been paid upfront, but it is not considered an expense yet in a business’s financial records. Within the realm of deferrals, common examples include prepaid expenses, supplies, and unearned revenue. On the other hand, accruals typically involve accrued expenses and accrued revenue. Additionally, depreciation entries include depreciation expense and accumulated depreciation, which tracks the total depreciation taken on an asset over time. So now that we’ve got a handle on that, you’re probably wondering, what kind of journal entries do we make to record the $100 of insurance we’ve used and the $1,100 of prepaid insurance left? The income statement account Supplies Expense has been increased by the $375 adjusting entry.

Deferrals refer to revenues or expenses that have been received or paid in advance but have not yet been earned or used. For example, a company might pay for a year’s worth of insurance in December, but this would be an expense for the following year. Another example is unearned revenue, where a customer has paid for services that have not yet been rendered. At the end of each month, an adjusting entry of $400 will be recorded to debit Insurance Expense and credit Prepaid Insurance. Prepaid insurance is one of the topics related to asset recognition, expense allocation, and adjusting entries for CFA Level I Financial Reporting. By doing so, analysts can better understand the level of financial health and performance of a company.

Prepaid Insurance Journal Entry: Recording and Adjusting in Accounting

This journal entry for a payment of this nature is referred to as prepaid insurance journal entry. It is a journal entry reflecting insurance premium the business has paid in advance. Since you have yet to receive the benefit, you consider the amount paid as an asset.

In contrast, an accrual is when revenue or an expense is recognized before cash is exchanged. This situation arises when a company incurs an expense or earns revenue but has not yet received or paid cash. For instance, if a company provides a service and invoices the client, the revenue is recorded at the time of service, even if payment is received later. Ignoring adjusting entries for prepaid insurance is like ignoring that check engine light—eventually, it catches up with you. By staying on top of these adjustments, you’re not just crunching numbers; you’re safeguarding your business’s financial integrity.