Journal Entry for Prepaid Insurance
Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurer. The company sells the policy to the customer and may offer other types of coverage.
The main purpose of insurance is to protect the insured from catastrophic loss and to spread financial risk over a large number of people. There are different types of insurance policies available, and they can be tailored to meet the needs of the customer. Some common types of insurance include life, health, automobile, homeowners, and renters insurance.
At most companies, insurance is considered an operational expense and recorded on the income statement. However, the insurance company may require the customers to pay in advance. The advance payment is recorded as prepaid insurance on the customers’ financial statements. The prepaid insurance is the current assets on the company balance sheet.
Companies often have to pay insurance fees in advance, which means they need to record the payments as current assets. This can be a challenge, particularly if the company has to make monthly payments. The best way to handle this is to allocate the payments to expenses on a monthly basis. This will ensure that the asset is properly accounted for and that the company’s financial statements are accurate. It’s important to keep track of these payments, as they can have a significant impact on the company’s bottom line. By recording them accurately and allocating them properly, businesses can avoid problems down the road.
Journal Entry for Prepaid Insurance
The prepaid insurance will be recorded when the company makes payment to the insurance company. It is recorded as the current assets on the balance sheet. It is expected to reverse to expense within a year.
When making a payment, the cash balance will decrease and increase the prepaid insurance.
The journal entry is debiting prepaid insurance and credit cash.
| Account | Debit | Credit |
|---|---|---|
| Prepaid Insurance | XXX | |
| Cash | XXX |
The journal entry is increasing prepaid insurance on the balance sheet.
The prepaid insurance will be allocated to the insurance expense base on the coverage time. The balance will be reversed from prepaid insurance to expense on the income statement.
The journal entry is debiting insurance expenses and credit prepaid insurance.
| Account | Debit | Credit |
|---|---|---|
| Insurance Expense | XXX | |
| Prepaid Insurance | XXX |
Example
On 01 Jan, company ABC purchase the insurance cost $ 12,000 from the insurance company. The insurance will cover from 01 Jan to 31 Dec of the year. Please prepare journal entry for the prepaid insurance.
The company pays the insurance fees in advance, it cannot record it as an expense yet. It must be recorded as prepaid insurance which is the current assets.
On 01 Jan, the company make journal entry debiting prepaid insurance $ 12,000 and credit cash $ 12,000.
| Account | Debit | Credit |
|---|---|---|
| Prepaid Insurance | 12,000 | |
| Cash | 12,000 |
On 31 Jan, the company needs to reverse the prepaid insurance to the expense. The journal entry is debiting insurance expense $ 1,000 ($ 12,000/ 12 months) and credit prepaid insurance $ 1,000.
| Account | Debit | Credit |
|---|---|---|
| Insurance Expense | 1,000 | |
| Prepaid Insurance | 1,000 |
