How to Calculate Prepaid Insurance

Monitor changes in real time to identify and analyze customer risk signals. This final entry will close out your Prepaid Insurance balance to $0, while your Insurance Expense for the year will be $12,000. Company XYZ has paid an insurance expense of $500 for the next quarter. This adjusting entry is necessary for the company to not overstate its total assets as well as to not understate its total expenses during the period. Followed by this adjusting entry, the remaining balance of Insurance expense amounts to $5,500.

The remainder is left over for the stock holders and taxes — this money is reinvested into investments and increases shareholder’s equity, which increases the value of the insurance company to stock holders. BlackLine Account Reconciliations, a full account reconciliation solution, has a prepaid amortization template to automate the process of accounting for prepaid expenses. It stores a schedule of payments for amortizable items and establishes a monthly schedule of the expenses that should be entered over the life of the prepaid items. Working capital, cash flows, collections opportunities, and other critical metrics depend on timely and accurate processes.

Prepaid Insurance and the Asset Account

Prepaid insurance is usually considered a current asset, as it will be converted to cash or used within a fairly short time. A business buys one year of general liability insurance in advance, for $12,000. 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. 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. When the insurance premiums are paid in advance, they are referred to as prepaid.

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• As you move through the year and consume the insurance, your prepayment gets used up.
• She is an IRS Enrolled Agent and has been a writer for these topics since 2010.
• Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

This keeps on reducing overtime, and for every subsequent month, the amount is expensed as the service is utilized. Subsequently, it is essential to adjust entry to change the prepaid insurance figure at the end of every month and expense the appropriate amount in the Income Statement. Here’s a guide on how these premiums are calculated, and how to reduce them. Let’s say a delivery company takes out some commercial auto insurance for its fleet of cars. However, it not until month six that the company has used all of the $24,000 worth of insurance.

How to record prepaid insurance

When they aren’t used up or expired, these payments show up on an insurance company’s balance sheet. As a business owner, you might make a decision to prepay your company insurance premiums. If you use an accrual basis accounting method, learn how prepayment affects your assets and expenses so you can report the transaction appropriately on financial statements. Prepaid insurance (and how it’s accounted for in the balance sheet) isn’t something the majority of us need to worry about. However if you are using the accrual basis accounting method at your company, then prepaid insurance might come into play.

Property taxes are often paid every six months, and require the same treatment. A business may collect a prepayment for sales on product that has not been delivered, and these sales must be entered as deferred revenue. One common example of an early prepayment is insurance coverage, which is often paid upfront to cover multiple future periods. The prepaid expense line item stems from a company paying in advance department of labor for products/services anticipated to be used at a later date. Despite the “expense” in the name, the company receives positive economic benefits from the expense over the course of several periods, hence its classification as a current asset. Prepaid Expenses refer to payments made in advance for products or services expected to be received on a later date — most often related to utilities, insurance, and rent.

Why Companies Count Prepaid Insurance

Prepaid insurance requires you to pay your premium before receiving the financial benefits of the policy. Insurers commonly offer prepayment for many types of insurance, including auto and homeowners insurance. At the end of each month, an adjusting entry of $400 will be recorded to debit Insurance Expense and credit Prepaid Insurance. Gain global visibility and insight into accounting processes while reducing risk, increasing productivity, and ensuring accuracy. Close the gaps left in critical finance and accounting processes with minimal IT support. To mitigate financial statement risk and increase operational effectiveness, consumer goods organizations are turning to modern accounting and leading best practices.

• For instance, you might pay $1.50 each day you drive plus $0.06 per mile.
• Like all financial products, prepaid insurance has both advantages and disadvantages to consider.
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• Do not record the $1,200 you initially pay as an expense on the statement of cash flows.

Sometimes, businesses prepay expenses because they can receive a discount for prepayment. Prepaid expenses may also provide a benefit to a business by relieving the obligation of payment for future accounting periods. There may also be tax benefits concerning prepaid expenses, however, all organizations must follow the proper rules related to tax deductions. 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.

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We can also see “Other Assets” and “Other Liabilities” are about equal, so we’ll net and ignore these. Every executive is committed to ensuring transformational success for every customer. Our API-first development strategy gives you the keys to integrate your finance tech stack – from one ERP to one hundred – and create seamless data flows in and out of BlackLine. BlackLine Magazine provides daily updates on everything from companies that have transformed F&A to new regulations that are coming to disrupt your day, week, and month. Streamline and automate detail-heavy reconciliations, such as bank reconciliations, credit card matching, intercompany reconciliations, and invoice-to-PO matching all in one centralized workspace.

Prepaid expenses are considered a current asset because they are expected to be consumed, used, or exhausted through standard business operations with one year. Prepaid expenses are initially recorded as assets, but their value is expensed over time onto the income statement. Unlike conventional expenses, the business will receive something of value from the prepaid expense over the course of several accounting periods.

Other less common prepaid expenses might include equipment rental or utilities. You may be wondering why we singled out insurance companies as not having the option to treat the prepaid insurance as revenue right away and move on. That’s because the IRS requires larger corporations to use the accrual basis accounting method. While the qualifications are out of the scope of this article, it’s safe to say that no insurer will ever qualify to use the cash basis accounting method. The company can record the prepaid insurance with the journal entry of debiting the prepaid insurance account and crediting the cash account. It is a good sign for the company, as it likes to pay off expenses before the due date.

It reflects the strong earning power of the company and creates goodwill in the market. Companies that take care of assets and employees by paying reasonable advance insurance premiums are considered strong financial companies. There should always be a check regarding the period for advance in insurance. A company shouldn’t advance too much as it may reflect badly on the profitability.