Why would Prepaid Insurance have a credit balance?

The company records the refund with a debit to Cash and a credit to Prepaid Insurance. Prior to issuing the December 31 financial statements, the company must remove the $120 credit balance in Prepaid Insurance by debiting Prepaid Insurance and crediting Insurance Expense. Prepaid rent involves payments made for property or equipment use before the rental period begins. This is particularly relevant for businesses with long-term leases. Prepaid assets are a key aspect of financial management, representing payments made for goods or services to be received in the future.

What Does Prepaid Mean in Accounting?

That means you also have a little less prepaid insurance left to sit on. 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.

Why would Prepaid Insurance have a credit balance?

Before diving into insurance, let’s recap the basics of debits and credits. Company A signs a one-year lease on a warehouse for $10,000 a month. The landlord requires that Company A pays the annual amount ($120,000) upfront at the beginning of the year. Expenses are recognized when they are incurred regardless of when paid. Expenses are considered incurred when they are used, consumed, utilized or has expired.

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. This is usually done at the end of each accounting period through an adjusting entry. Your prepaid insurance asset account will magically increase, while your cash account takes a hit. To keep your books in tip-top shape, you need to make an adjusting entry each sales journal entry month.

• Initially, these assets appear on the balance sheet, bolstering the asset side.
• The entity needs to pay the insurance fees on a yearly basis in order to receive the insurance cover.
• However, the premiums may be marginally higher to account for inflation and other operating factors.
• Prepaid Insurance represents insurance premiums paid to insurers in advance.
• You decide to purchase an insurance policy for a year, but you pay for the entire coverage upfront.
• On December 31, an adjusting entry will show a debit insurance expense for $400—the amount that expired or one-sixth of $2,400—and will credit prepaid insurance for $400.

GVG Company acquired a six-month insurance coverage for its properties on September 1, 2021 for a total of $6,000. Prepaid insurance is credited to reduce the asset, reflecting there is now less unused insurance. Prepaid insurance is credited to reduce the leftover unused amount of the asset. With this foundation, let’s look at some insurance accounting examples.

Prepaid Insurance is the insurance premium paid by a company in an accounting period that didn’t expire in the same accounting period. Therefore, the unexpired portion of this insurance will be shown as an asset on the company’s balance sheet. Some insurance bills relate to the prior accounting period but are paid in the current period.

When to Debit vs Credit Insurance

Understanding whether insurance is a debit or credit transaction is the key first step. This gradually expenses the original prepaid asset over the policy term. Cash, another asset account, is decreased by the premium payment amount with a credit.

Prepaid Insurance Journal Entry

The insurance used for December will be reported as an Insurance Expense on December’s income statement. HighRadius empowers accounting teams to work more efficiently, accurately, and collaboratively, enabling them to add greater value to their organizations’ accounting processes. CFI is the global institution behind the accounting practice academy financial modeling and valuation analyst FMVA® Designation.

Accurate accounting for prepaid assets begins with recognizing these payments as assets on the balance sheet at the time of the transaction. This classification is necessary because the payment represents a future economic benefit, aligning with the definition of an asset under both GAAP and IFRS. For example, if a business purchases a $10,000 annual maintenance contract, the prepaid expense account reflects this amount until the service is utilized. 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, cash receipt prepaid expenses are expenditures paid in one accounting period, but will not be recognized until a later accounting period. Prepaid expenses are initially recorded as assets, because they have future economic benefits, and are expensed at the time when the benefits are realized (the matching principle).

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• The expense would show up on the income statement while the decrease in prepaid rent of $10,000 would reduce the assets on the balance sheet by $10,000.
• By following these guidelines, companies can accurately record and report prepaid insurance on their balance sheets.
• In double-entry accounting, every transaction requires at least two entries – a debit and a credit.
• It also sets up automatic monthly adjusting entries to debit Insurance Expense for $200 and to credit Prepaid Insurance for $200 on the last day of each month.
• The initial entry is a debit of $12,000 to the prepaid insurance (asset) account, and a credit of $12,000 to the cash (asset) account.
• Most calculations dealing with prepaid insurance involve determining how much of that prepaid insurance expense is recognized in each accounting period.

For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online.

Companies can use amortization data to optimize spending patterns, negotiate better terms with suppliers, or adjust pricing strategies to maintain a competitive advantage. On the income statement, insurance expenses are deducted as part of total expenses to determine net income. The liability account is debited to zero out the balance, and cash is credited to record the payment. The final adjusting journal entry is done in the third month, bringing the balance in Prepaid Rent to zero. On 01 July 2022, company purchased insurance for $ 12,000 to cover from 01 July 2022 to 30 June 2023.

Let us look at the balance sheet at the end of one month on December 31, 2017. Some insurers prefer that insured parties pay on a prepaid schedule such as auto or medical insurance. For example, paying $500 each month over the course of a 12-month policy.