Journal entry for insurance premium paid for next year
In business, we may need to make a one-year advance payment for the insurance policy that we need to purchase. In this case, we need to make the journal entry for the insurance premium paid for next year by recognizing and recording the amount paid as an asset on the balance sheet.
Likewise, we do not record the insurance expense yet when we make the payment for the insurance premium that covers the next year. This is because the insurance expense will only occur in next year which is the period that it covers.
In accounting, similar to rent expense, the insurance expense occurs through the passage of time. In this case, we need to charge the expired cost of insurance to the income statement as an insurance expense. This is usually done through the amortization of prepaid insurance on a monthly basis.
Journal entry for insurance premium paid for next year
We can make the journal entry for the insurance premium paid for next year by debiting the amount paid to the prepaid insurance account and crediting the same amount to the cash account.
| Account | Debit | Credit |
|---|---|---|
| Prepaid insurance | XXXX | |
| Cash | XXXX |
The prepaid insurance account is a type of asset on the balance sheet in which its normal balance is on the debit side. As mentioned, since the insurance premium paid is for next year, there is no expense occurring at the time of payment yet. Likewise, this journal entry only increases one asset while decreasing another asset on the balance sheet at the same time.
As the insurance expense occurs through the passage of time, the insurance premium paid for next year can be recorded as an expense in the next year period when it is expired.
Likewise, when the insurance premium that we have paid is expired, we can make the journal entry to transfer the amount of prepaid insurance to the insurance expense as below:
| Account | Debit | Credit |
|---|---|---|
| Insurance expense | XXXX | |
| Prepaid insurance | XXXX |
In this journal entry, the total expenses on the income statement will increase as a result of insurance expiration. On the other hand, the balance of prepaid insurance on the balance sheet will decrease by the same amount.
Example of insurance premium paid
For example, on December 31, we make a payment of the insurance premium amounting to $3,000 for the next year’s period. This $3,000 insurance premium will cover from the beginning of January to the end of December next year.
In this case, we can make the journal entry for insurance premium paid for next year with the debit of $3,000 into the prepaid insurance account and the credit of cash account with the same amount as below:
December 31:
| Account | Debit | Credit |
|---|---|---|
| Prepaid insurance | 3,000 | |
| Cash | 3,000 |
Later, when a portion of the insurance premium that we have paid has expired each month, we can record the expired cost as an expense on a monthly basis with the amortization of prepaid insurance. This can be done by dividing the $3,000 by the 12 months period.
For example, we can make the journal entry for amortization of the prepaid insurance in the January 31 adjusting entry of the next year with the $250 ($3,000 / 12 months) as below:
January 31:
| Account | Debit | Credit |
|---|---|---|
| Insurance expense | 250 | |
| Prepaid insurance | 250 |
The $250 of the insurance expense is an expired cost of insurance premium that we can charge to the income statement for the month of January. Likewise, the balance of prepaid insurance will be reduced to $2,750 ($3,000 – $250) as of January 31.
Likewise, at the end of next year, the balance of prepaid insurance in this example will become zero as it will be fully charged to the income statement as the insurance expense.
Amortization of the prepaid insurance
As prepaid insurance is the type of asset that will expire through the passage of time, we need to record the expired cost as an expense to the income statement for the period. Likewise, we can do this by making the amortization of the prepaid insurance with the time period it covers.
Like in the example above, we amortize the $3,000 prepaid insurance with the 12 months period that it covers by dividing this amount by 12 resulting in a $250 per month. Then we can record this $250 expired cost of insurance as an expense to the income statement for the period.
In some jurisdictions, the amortization of prepaid insurance is a must and the companies that fall under such jurisdictions need to comply. This is usually to prevent the understatement of the insurance expense that may occur if the companies do not properly amortize their prepaid insurance on a monthly basis.