Let’s say you purchase a one-year home insurance policy for $1,200. A prepaid expense is an asset on a balance sheet that results from a business making advanced payments for goods or services to be received in the future. 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. Insurance premiums, prepaid rent, salaries, taxes, or any interest or installment paid for office equipment are all examples of prepaid expenses.

When insurance is prepaid, the accountant sets up an amortization worksheet. Determine the number of periods over which the prepaid amount will be amortized. Prepaid insurance is common with some types of insurers, such as for auto and health. For example, you may pay a monthly fee of $30 plus $0.06 per mile. When canceling an insurance policy, you may incur a cancellation fee. FREE INVESTMENT BANKING COURSELearn the foundation of Investment banking, financial modeling, valuations and more. Let us look at the balance sheet at the end of one month on December 31, 2017.

Why Is Prepaid Insurance Important?

When the insurance coverage comes into effect, it is moved from an asset and charged to the expense side of the company’s balance sheet. Insurance coverage, though, is often consumed over several periods. In this case, the company’s balance sheet may show corresponding charges recorded as expenses. The business’s records would show four months of insurance policy as a current, prepaid asset. As a self-insurer, the employer must show proof of financial solvency and ability to pay benefits by furnishing DLIR with the latest audited financial statements for review.

The landlord requires that Company A pays the annual amount ($120,000) upfront at the beginning of the year. The product then automatically amortizes the expense over future periods, eliminating the need to manage spreadsheets or other manual tracking systems.

Prepaid Insurance

Just like any balance sheet account, we can prepare a balance sheet rollforward. Simultaneously, as the company’s recorded balance decreases, the expense appears on the income statement in the period corresponding with the coinciding benefit. Prepaid expenses in one company’s accounting records are often—but not always—unearned revenues in another company’s accounting records. Office supplies provide an example of a prepaid expense that does not appear on another company’s books as unearned revenue. Is the Fees Earned account classified as an asset, a liability, an owner’s equity, a revenue, or an expense account? Is the Supplies account classified as an asset, a liability, an owner’s equity, a revenue, or an expense account? Supposing a company has paid commercial property insurance for a building for $60,000 that covers an entire year.

• This enables the most accurate reflection of assets in the short term, as well as profit.
• If the period of coverage is longer than one year, then the asset must be listed as a long-term asset at the end of the year.
• A prepaid expense is an expenditure that a business or individual pays for before using it.
• At the end of each accounting period, adjusting entries are necessary to recognize the portion of prepaid expenses that have become actual expenses through use or the passage of time.
• Prepaid insurance requires you to pay your premium before receiving the financial benefits of the policy.
• The company should expense what has been incurred as of the end of Year 3.

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Enter the monthly expense for each accounting period

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In January, the company records a journal entry to recognize 1/12 of the value of the insurance policy. https://www.bookstime.com/ The journal entry debits an insurance expense account and credits prepaid expenses for $1,500.

Maximize working capital and release cash from your balance sheet. The expense is marked as prepaid if the PrepaidFlag parameter is set to ‘Y’ in the expense payload. Mary Girsch-Bock is the expert on accounting prepaid insurance software and payroll software for The Ascent. Get instant access to video lessons taught by experienced investment bankers. Learn financial statement modeling, DCF, M&A, LBO, Comps and Excel shortcuts.