is prepaid insurance an asset

Prepaid insurance is an advance payment made by individuals or corporate organizations to insurance companies for various insurance coverage. Since this payment is usually made in advance, it is an asset to the individual or corporate organization that made the payment. Although most insurance payments cover one month, a lot of insurance companies encourage their patrons to make a lump sum payment which will cover a period of one year or six months. These insurance companies generally offer a payment discount for patrons who choose to make this lump sum payment instead of the regular monthly payment.

And according to GAAP (generally accepted accounting principles), when you record an expense, you must realize the benefit from the asset in the same accounting period. Once the period of insurance comes into effect, monthly deductions are made from the prepaid insurance to record the reduction in the amount that is still considered a current asset. This is What to Expect from Accounting or Bookkeeping Services because the company has paid an expense in advance, which will help to ease the expense later. As the expense is paid beforehand, it is treated as a prepaid expense and recorded accordingly. Yearly accounting of a company is done as per financial year, so it is treated as an asset if insurance expense for the next financial year is already paid this year.

What are Prepaid Expenses Definition in Accounting?

The trial balance, drawn up on 31 December 2019, assumed that he had no other insurance and his insurance expenses account would show a balance of $4,800. Not to mention, Kolleno’s software is also designed to remove manual Excel spreadsheet-reliant procedures to automate the entire accounting process for a wide range of companies. When you lease an office space, you can pay in advance to lock in the price or avail a discount. Like all financial products, prepaid insurance has both advantages and disadvantages to consider. Insurance companies often offer incentives to customers who prepay their premiums, but this type of plan requires making a large lump-sum payment.

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. Prepaid expenses appear on a business’s balance sheet as current assets unless they will not be incurred within 12 months. As the prepaid expense is consumed, the amount recognised as an asset on the balance sheet decreases and the amount recognised as an expense on the income statement increases. The initial journal entry for a prepaid expense does not affect a company’s financial statements. The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash. In other words, unless the value of the asset is not realised until 12 months have passed, prepaid expenses have to be recorded as a current asset.

Example of Prepaid Expense

When the benefits of prepaid expenses are realized, they are recorded as an expense on the income statement. It is crucial to remember that these costs are initially not listed on the income statement due to the GAAP matching concept. When it incurs prepaid expenses, a company pays in advance for goods or services that will be provided in the future.

  • All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
  • By using prepaid expenses, businesses can better manage their future tax deductions.
  • It is a current asset if it covers a month or one year and a non-current asset if it covers more than one year.
  • You must pay prepaid expenses upfront before you receive any type of benefit.
  • Prepaid insurance is considered a prepaid asset because it benefits future accounting periods.
  • The second entry, however, does affect both the income statement and the balance sheet.

The payment of expense in advance increases one asset (prepaid or unexpired expense) and decreases another asset (cash). Supposing a company has paid commercial property insurance for a building for $60,000 that covers an entire year. Each month after coverage begins, $5,000 is transferred from asset to expense. Prepaying your insurance premium might complicate the cancellation process.