A business may gain from prepaid expenses by avoiding the need to make payments for upcoming accounting periods. As the insurance policy term progresses, the prepaid asset is gradually used up. As you can see, we debit the Prepaid Insurance account by $10,000, bumping up your assets, and credit the Bank account by $10,000, reflecting less cash on hand. Now, as each month rolls by and some of that insurance coverage is used up, you’ll need to adjust your accounts accordingly. Since the insurance covers a year, divide $10,000 by 12 months, giving you an $833 expense each month (we’ll ignore the extra pennies for simplicity’s sake). In simple terms, prepaid insurance is the money you pay upfront to your insurance company before you get to enjoy any of their coverage.

In each of the successive months, equal parts insurance will continue to be credited from the prepaid insurance account. Then, every month for the next twelve months, ABC Company makes adjusting entries to debit the insurance expense account and credit the prepaid insurance account by $100. 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. Prepaid insurance is a fee paid by individuals or businesses to their insurers in advance for insurance services or coverage. It is considered a prepaid expense, which is an expense paid for in advance but not yet incurred. In accounting, prepaid expenses are initially recorded as assets on the balance sheet, but their value is expensed over time onto the income statement.

• Because companies anticipate them to be consumed, employed, or spent through regular business activities within a year.
• You debit prepaid insurance because it’s increasing your assets (future benefits) and credit cash because, well, money just left your pocket.
• This is done with an adjusting entry at the end of each accounting period (e.g. monthly).
• This assists students with comprehension on how to implement accrual accounting methods, asset type and expense matching–all of which are helpful in generating accurate financial statements.

Adjusting Journal Entry for Prepaid Insurance

Prepaid insurance is commonly recorded because insurance providers prefer to adjusting entries for prepaid insurance bill insurance in advance. If a business were to pay late, it would risk having its insurance coverage terminated. At the end of each month or accounting period, you would need to make adjustments to your books. You need to allocate some of the amount paid in advance to the Insurance Expense account.

The company can record the prepaid insurance with the journal entry of debiting the prepaid insurance account and crediting the cash account. Prepaid insurance is adjusted to account for the portion of the insurance that has expired over the accounting period. This ensures your financial statements accurately reflect your assets and expenses, preventing any misrepresentation of your company’s financial health.

Adjusting entries are used to balance the books

• Then, every month for the next twelve months, ABC Company makes adjusting entries to debit the insurance expense account and credit the prepaid insurance account by $100.
• Within the realm of deferrals, common examples include prepaid expenses, supplies, and unearned revenue.
• This shifts the expired amount from an asset to an expense, aligning with the matching principle.
• The debit entry to insurance expense will result in adding the expenses whereas credit to the prepaid expense account will result in decreasing the current asset.

For example, if a company pays $12,000 for a year’s rent in advance, it debits Prepaid Rent and credits Cash. After four months, an adjusting entry would debit Rent Expense for $4,000 (4 months x $1,000/month) and credit Prepaid Rent for $4,000. This reflects the portion of the prepaid asset that has been used up, ensuring the financial statements accurately represent the company’s expenses and remaining prepaid assets. In each of the next twelve months, there should be a journal entry that debits the insurance expense account and credits the prepaid expenses (asset) account.

Prepaid Insurance Journal Entry CFA Questions

For example, 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 recorded with a debit of $2,400 to Prepaid Insurance and a credit of $2,400 to Cash. On November 30, none of the $2,400 has expired, and the entire amount is reported on the balance sheet as Prepaid Insurance. On December 31, an adjusting entry will debit Insurance Expense for $400 (1/6 of $2,400) and credit Prepaid Insurance for $400. This process is repeated at the end of each month, with an adjusting entry of $400 recorded to debit Insurance Expense and credit Prepaid Insurance.

Adjusting Entry for Prepaid Insurance

In the business, the company usually needs to make an advance payment for the insurance that it has purchases. In this case, it is important for the company to record the payment as prepaid insurance. This reconciliation process substantiates the asset value on the balance sheet and serves as an important internal control, providing assurance that prepaid assets are accurately reported. The company increases its assets by debiting the Prepaid Insurance account for the full premium amount.

The insurance expense account is debited $400 and the prepaid insurance account is credited $400. This process is repeated each month until the insurance is fully expensed and the prepaid insurance asset account balance is zero. For example, consider a business that buys one year of general liability insurance in advance for $12,000.

In the company’s books, this prepaid insurance is an asset—specifically, a current asset—because it covers a period within one year. A total of ₹18,000 gets expensed over six months using prepaid insurance journal entry adjustments. The main advantage of prepaid insurance is that companies occasionally pay bills in advance to gain a discount.

Adjustment entry for Prepaid Expenses

So, when making a journal entry for prepaid insurance, you record the prepaid expense in your books and adjust the entries as you use up the service. Sometimes in business, you have to pay for stuff upfront before you even get to use it. We’re talking about expenses like prepaid expenses, which are one of the essential types of adjusting entries in accounting. Think of prepaid rent and prepaid insurance—they’re like the Beyoncé and Jay-Z of the prepaid expenses world. Passing adjustment entries to balance the books of accounts is often helpful, preventing one from making an entry for new business transactions.

In each successive month for the next twelve months, there should be a journal entry that debits the insurance expense account and credits the prepaid expenses (asset) account. Prepaid insurance is initially recorded as an asset, but its value is expensed over time onto the income statement. The full value of the prepaid insurance is recorded as a debit to the asset account and as a credit to the cash account. Each month, as a portion of the prepaid premiums are applied, an adjusting journal entry is made as a credit to the asset account and as a debit to the insurance expense account.

Introduction to Adjusting Journal Entries Video Summary

As each month passes, one rent payment is credited from the prepaid rent asset account, and a rent expense account is debited. This process is repeated as many times as necessary to recognize rent expense in the proper accounting period. The correct balance should be the cumulative amount of depreciation from the time that the equipment was acquired through the date of the balance sheet. A review indicates that as of December 31 the accumulated amount of depreciation should be $9,000.