Insurance coverage, though, is often consumed over several periods. In this case, the company’s balance sheet may show corresponding charges recorded as expenses. During this period, companies must transfer the expired portion of the premium to the income statement.
In this case, assuming that the service represented by the asset expires equally each month, the Prepaid Insurance account must be reduced by $900. The matching convention requires allocation of the expenditure between the asset that represents the remaining economic benefits and the expense that represents the benefits used or consumed by the firm. BlackLine is an SAP platinum partner and a part of your SAP financial mission control center. Our solutions complement SAP software as part of an end-to-end offering for Finance and Accounting.
Prepaid Insurance: Definition, How It Works, Benefits, and Example
A common financial question we see asked is related to prepaid insurance. Prepaid insurance is exactly what it sounds like – insurance that’s been prepaid. Just pay the bill when it arrives, then rest easy knowing that you’re protected. As the policy is consumed from month to month, the policy’s value for those months will be recorded as a credit, and the entries in the two columns will eventually cancel out or total zero. More than 4,300 companies of all sizes, across all industries, trust BlackLine to help them modernize their financial close, accounts receivable, and intercompany accounting processes.
For example, the $1,200 prepaid policy will reduce in value by $100 each month, which you adjust in your ledger. At this point, the $12,000 is classified as a current asset (Prepaid Insurance) on TechFirm’s balance sheet. Prepaid insurance is what is prepaid insurance in accounting an asset account as it represents the advance amount paid by a firm to the insurer for the insurance services of the upcoming fiscal period. Abdul Co. has a new insurance policy that requires them to pay $2,400 per year, in a lump sum manner.
Prepaid Insurance: Understanding the Ins and Outs of this Account
For example, if a large copying machine is leased by a company for a period of 12 months, the company benefits from its use over the full-time period. Companies make prepayments for goods or services such as leased office equipment or insurance coverage that provide continual benefits over time. Goods or services of this nature cannot be expensed immediately because the expense would not line up with the benefit incurred over time from using the asset. The business’s records would show four months of insurance policy as a current, prepaid asset. 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.
This process is typically done monthly or annually, depending on the company’s accounting policies. Prepaid expenses are not recorded on an income statement initially. Instead, prepaid expenses are first recorded on the balance sheet; then, as the benefit of the prepaid expense is realized, or as the expense is incurred, it is recognized on the income statement. Therefore under the accrual accounting model an entity only recognizes an expense on the income statement once the good or service purchased has been delivered or used.