The payment of the insurance expense is similar to money in the bank, and the money will be withdrawn from the account as the insurance is “used up” each month or each accounting period. Prepaid insurance is usually considered a current asset, as it will be converted to cash or used within a fairly short time. If the premium were $1,200 per year, for instance, you would record the check for $1,200 as a credit to the cash account in your journal, decreasing the value of that account. Then you would enter a debit of $1,200 to the prepaid insurance asset account, increasing its value.

  • As per the golden rules of accounting (for personal accounts), prepaid insurance is debited.
  • For example, if an asset account which is expected to have a debit balance, shows a credit balance, then this is considered to be an abnormal balance.
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  • For example, if a business had purchased six months of insurance and decided to cancel the policy after two months, it could redeem the value of the four remaining unused months of coverage.
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As per the Modern Rules of Accounting

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He is the sole author of all the materials on AccountingCoach.com. Woodman’s articles have been published in “Professional Distributor” magazine and in various online publications. He has written extensively on automotive issues, business, personal finance and recreational vehicles. Woodman is pursuing a Bachelor of Science in finance through online education.

Transform your accounts receivable processes with intelligent AR automation that delivers value across your business. The debit balance at the end of the year is shown on the asset side of the balance sheet and the amount is carried forward to the next year. Prepaid Expenses are referred to as representative personal accounts (accounts that represent a certain person or group of people). According to the rule for personal accounts, we have to debit the receiver of the benefit and credit the giver of the same. Prepaid insurance is 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. Any money you spend with a prepaid card is deducted from your card balance, not your bank account.

Common Reasons for Prepaid Expenses

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Alternatives to Prepaid Insurance

As mentioned above, the premiums or payment is recorded in one accounting period, but the contract isn’t in effect until a future period. A prepaid expense is carried on an insurance company’s balance sheet as a current asset until it is consumed. That’s because most prepaid assets are consumed within a few months of being recorded. Prepaid insurance is considered a business asset, and is listed as an asset account on the left side of the balance sheet.

Is prepaid expense debit or credit?

The company records the refund with a debit to Cash and a credit to Prepaid Insurance. At December 31, the balance in Prepaid Insurance will be a credit balance of $120, consisting of the debit of $2,400 on January 1, the 12 monthly credits of $200 each, and the $120 credit on July 1. 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.

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The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash. The payment is entered on November 20 with a debit of $2,400 to prepaid insurance and a credit of $2,400 to cash. Certain expenses, such as taxes and insurance, are paid in lump sums during one particular accounting period. The benefits from these payments extend past the single accounting period, so it is not accurate to charge the full payment to an expense account at that time. These types of payments are handled using a prepaid expense account.

Each month, adjust the accounts by the amount of the policy you use. The single biggest reason why I always make sure to pay insurance premiums annually is because doing so saves me money. Many insurers provide around a 5% to 10% discount to policyholders who make a single lump sum payment or who pay just twice a year instead of breaking up the premium into many smaller payments. It is considered a prepaid asset, which is a way to express these benefits in accounting terms. Gain global visibility and insight into accounting processes while reducing risk, increasing productivity, and ensuring accuracy.

Thus, prepaid insurance has a debit balance just like any other asset and it is debited in the books of accounts. Prepaid insurance is considered a prepaid asset because it benefits future accounting periods. It relieves them of the monthly premium expense, and in doing so, reduces their costs, while at the same time still conferring the benefit of having coverage for the business. These are both asset accounts and do not increase or decrease a company’s balance sheet.

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