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For example, if you pay your $1,500 annual home insurance premium in one payment, then sell your house six months into the policy’s term, the insurer will have to refund the unused premium. Although providers do issue prorated refunds, you may have to wait days or weeks to receive the money. Prepaid insurance works similarly to many products or services you pay for fully in advance.

What is an asset?

Every company pays insurance premiums either monthly, quarterly, or annually. So when a company has paid the insurance premium in advance for the next period, that extra payment is recorded as prepaid insurance on the Asset side of the Balance sheet. So every company treats it as an asset, and when the period comes, the appropriate amount is shown as an expense under the Insurance expense. Prepaid expenses represent expenditures that have not yet been recorded by a company as an expense, but have been paid for in advance. In other words, prepaid expenses are expenditures paid in one accounting period, but will not be recognized until a later accounting period.

This allows for accurate reporting for each different transaction type that occurs during normal operations. Multiple prepaid insurance policies can all reside in the same account, however, as they all represent the same type of transaction, like insurance purchases and expenditures. If you pay your rent in advance of the due date, this is prepayment. Payment is a current asset until your company begins using the office space or facility for the time you paid it. For instance, on October 30th, a company pays its office rent for November.

Why Is Prepaid Insurance Considered a Debit in the Asset Account?

A prepaid expense is an expense that has been paid for in advance but not yet incurred. In business, a prepaid expense is recorded as an asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Now that we know how crucial an accounting equation is, the same situation and equation also have to be kept in mind while prepaid expenses are dealt with. For prepaid expenses, people are often confused as to how a prepaid insurance accounting equation will be formed. Take a look down below and learn the recording of prepaid expenses in the accounting equation. The policies are intended to cover not only its property and products but also to protect its workers.

Our cloud software automates critical finance and accounting processes. We empower companies of all sizes across all industries to improve the integrity of their financial reporting, achieve efficiencies and enhance real-time visibility into their operations. Working capital, cash flows, collections opportunities, and other critical metrics depend on timely and accurate processes. Ensure services revenue has been accurately recorded and related payments are reflected properly on the balance sheet. Prepaid insurance can be classified as a current asset because it is used up or expires in a short period of time, usually one year, of the balance sheet date. In conclusion, prepaid insurance is an asset that is valuable to mitigate risks and uncertainties in a business.

• Take a look down below to learn how prepaid insurance works and much more.
• Let’s say a delivery company takes out some commercial auto insurance for its fleet of cars.
• A prepaid asset is an item for which a company pays but doesn’t receive the full benefit from the item.

Then subtract the appropriate portion off every accounting period — likely monthly, but possibly quarterly or annual. 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.

Recording Process

Insurance companies often offer incentives to customers who prepay their premiums, but this type of plan requires making a large lump-sum payment. When recording assets on the balance sheet, it is recorded on the left column while liabilities and equity are recorded on the right column. Advancements and the use of software in making the balance sheet have however made assets, liabilities, and equity all presented on one page with assets appearing first.

Depending on the policy, a business may pay their insurance premiums on a monthly, quarterly, or annual basis. When the business pays for the premiums upfront, they are paying in advance for the entire policy period. Therefore, the entire prepaid insurance expense is recorded on the “asset” side of the balance sheet. Insurance premiums paid in advance are first reported as a liability. Each month, companies need journal entries to ensure that (1) the current month’s expenses appear on the income statement. Also, (2) the prepaid insurance portion you didn’t use comes down from the asset account each month.

What is Prepaid Insurance?

When the policy goes into effect, you’ll then get the benefits of the coverage over a 12-month period. It’s only insurance companies, with the need to have pristine financial statements, that need to make sure every dollar is accounted for. For these businesses, any unused insurance that’s been received but haven’t expired count as an asset. To estimate the amount of a prepaid asset’s monthly benefit, divide the total cost of the asset by the number of months of benefits the asset represents. So, the allocation process is closely related to the term of service.

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. In conclusion, prepaid insurance is an important aspect of accounting that affects a company’s financial statements, cash flow, and taxation. It is necessary to record prepaid insurance as an asset on the balance sheet until it becomes an expense and to keep track of the balance to ensure that it is used within the coverage period. Therefore, it is imperative for companies to have a clear understanding of prepaid insurance and its place in accounting.

A business should conduct a careful analysis of its insurance needs before prepaying insurance premiums. When it comes to accounting for prepaid insurance, it’s important to understand the concept of depreciation. Depreciation refers to the process of allocating the cost of an asset over its useful life. While prepaid insurance is classified as an asset, it is important to remember that it represents a prepayment of future expenses, and thus requires special treatment in terms of depreciation.

How Does Prepaid Insurance Work?

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A premium is a regular, recurring payment made to a provider for the benefit of having insurance coverage. Insurance expense is the cost a company pays to get an insurance contract, as well as any unpaid monthly premium costs on the insurance contracts. All assets, liabilities, and equity of a company are represented on the balance sheet.

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The same applies to many medical insurance companies—they prefer being paid upfront before they begin coverage. When companies make an insurance payment in advance, they have to record this transaction in order to keep track of their finances and how money goes out of the company. This will guide us in understanding whether prepaid insurance is an asset or not.

• Similarly, a company that owns patents can use them to protect its products, which can increase its competitive advantage and lead to increased revenue.
• Whether you’re new to F&A or an experienced professional, sometimes you need a refresher on common finance and accounting terms and their definitions.
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• As the correct period approaches, it will be moved from the asset side and reflected under the expense.
• The insurance company will however inform their clients of any changes in the amount to be paid prior to subsequent payments.

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. Essentially, prepaid insurance is an asset till the insurance premium expires. Until then, companies must keep classifying the amount under current assets on the balance sheet. Once the premium expires, they must move the relevant portion to insurance-related expenses in the income statement. The effect of depreciating prepaid insurance on accounting can vary depending on the specific circumstances. Generally, recognizing depreciation will result in a reduction in the value of the prepaid insurance asset and an increase in the insurance expense account.

• Category: Bookkeeping
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