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Prepaid Insurance Journal Entry

The prepaid insurance journal entry follows the same accounting principle for all prepaid expenses. Sometimes, in business, some expenses are paid for in advance even when the full benefits or services are yet to be received during that period. Such expenses are known as prepaid expenses which are one of the types of adjusting entries in accounting. Prepaid rent and prepaid insurance are typical examples of prepaid expenses.

The advance payment of expenses does not provide value right away. Rather, they provide value over time; generally over multiple accounting periods. The reason is that the expense expires as you use it, thus, you can’t expense the entire value of the prepaid service immediately. You can only expense a portion of the expense that has been used. So when making a journal entry for prepaid insurance, you record the prepaid expense in your business financial records and adjust entries as you use up the service.

Prepaid insurance journal entry
Prepaid insurance journal entry

At the end of the accounting period, the expired portion of the prepaid insurance becomes part of the income statement like any other expense, while the unexpired portion of the prepaid insurance becomes part of the balance sheet like any other current asset. It is important to note that the process of recording any prepaid expense only takes place in accrual accounting. In this article, we will be discussing the prepaid insurance journal entry with some examples.

Related: Accrued expenses journal entry and examples

Prepaid insurance explained

Prepaid insurance is the payment associated with an insurance contract that has been paid by individuals and businesses in advance for insurance services or coverage. It is the amount expended for an insurance contract that has not yet been used through the passage of the time period stated in the contract. In the books, prepaid insurance is treated as an asset, which is charged gradually to expense over the period covered by the related insurance contract.

Insurance providers prefer to bill insurance in advance and so knowing the right journal entry for prepaid insurance is very important. For instance, the providers of medical insurance usually insist on advance payment, and if a business were to pay late, it would be at risk of having its insurance coverage terminated. Prepaid insurance is reported on the balance sheet as a current asset because the term of the related insurance contract that has been prepaid is usually for a period of one year or less.

However, if the advance payment covers a longer period, then the portion of the unexpired prepaid insurance that has not been charged to expense within one year will be reported as a long-term asset. In order to understand how prepaid insurance works, let’s take an example. Assume ABC company buys one-year insurance for its truck and pays $1200 for this insurance on December 1, 2022. In the company’s book, this prepaid insurance will be classified as an asset. In this case, it will be classified as a current asset on the Balance Sheet because it covers and falls within one year.

To get the insurance expense for each month we will divide $1,200 by the 12 months which gives us $100. This means that for one month, say between December 1, 2022, and December 31, 2022, $100 worth of insurance is used up. This means that at the end of one month, on December 31, 2022, the reporting amount of prepaid insurance on the balance sheet will be $1100 (i.e $1,200 – $100). While the insurance used for December ($100) will be reported on December’s income statement as an Insurance Expense.

Now, that we understand this, what journal entries will one make to record the $100 worth of insurance used and the $1,100 worth of prepaid insurance remaining? To answer this, let’s discuss the journal entry for prepaid insurance.

See also: Is prepaid rent debit or credit? examples in journal entry

Prepaid insurance journal entry

When an advance insurance payment is made, the prepaid insurance journal entry is a debit to the prepaid insurance account and a credit to the cash account. According to the accounting debit and credit rules, a debit entry increases assets, expenses, and dividends accounts while a credit entry decreases them. Prepaid insurance is an asset and going by the debit and credit rules, the prepaid insurance account increases by a debit entry while the cash account decreases by a credit entry.

Nonetheless, when the prepaid insurance has been used and charged to expense, the adjusting entry for prepaid insurance would be a debit to the insurance expense account and a credit to the prepaid insurance account. The insurance expense account increases by the debit entry while the prepaid insurance account decreases by the credit entry.

Journal entry of prepaid insurance when paid

AccountDebitCredit
Prepaid insurance00
Cash account00
Prepaid insurance journal entry

Adjusting entry for prepaid insurance

AccountDebitCredit
Insurance expense00
Prepaid insurance00
Prepaid insurance adjusting entry

See also: General Journal Examples – Entries and Calculations

Examples of journal entry for prepaid insurance

Let’s look at some examples to explain prepaid insurance journal entries.

Journal entry of prepaid insurance: example 1

Using our preceding example, where ABC company buys one-year insurance for its truck and pays $1200 for the insurance on December 1, 2022. The initial journal entry for prepaid insurance will be a debit of $1, 200 to the prepaid insurance account, and a credit of $1,200 to the cash account. That is:

Prepaid insurance journal entry for when insurance is paid

DateAccountDebitCredit
December 1, 2022Prepaid insurance A/c$1,200
Cash A/c$1,200
Prepaid insurance journal entry

Then, in each successive month for the next twelve months, there would be adjusting entries of prepaid insurance that debit the insurance expense account and credit the prepaid insurance account by $100.

Adjusting entry for prepaid insurance

DateAccountDebitCredit
December 31, 2022Insurance expense$100
Prepaid insurance$100
Expired prepaid insurance journal entry

Prepaid insurance journal entry: example 2

A company needs to pay its employee liability insurance for the fiscal year ending December 31, 2023, which costs about $10,000. If $10,000 of the insurance premium is paid by the company for the entire year at the beginning of the first quarter. This is the prepaid insurance journal entry that will be passed and reflected in the company’s books of accounts:

Prepaid insurance journal entry for when insurance is paid

AccountDebitCredit
Prepaid insurance A/c$10,000
Bank A/c$10,000
Prepaid insurance journal entry

As shown above, the Prepaid insurance account is debited with $10,000 to show an increase in assets, and the Bank account is credited with an equal amount to show a decrease in cash. When insurance is due and its coverage expires for each quarter, the accounts will be adjusted by the amount of the policy the company uses. Since the insurance lasts one year, we will divide the total cost of $10,000 by 12 (i.e we will adjust the accounts by $833 each month).

The company will expense $833 of the insurance with debit and reduce the Prepaid insurance account with a credit of the same amount. This adjusting prepaid insurance entry will be repeated each month until the full insurance coverage is used and the prepaid insurance (asset) account is empty. Hence, for each quarter we will have an insurance expense of $2,500 (i.e $833 x 3). This means the expired prepaid insurance journal entry for that reporting quarter of the year will be:

Expired prepaid insurance journal entry

AccountDebitCredit
Insurance expense$2,500
Prepaid insurance$2,500
Expired prepaid insurance journal entry

The income statement for the quarter ending will, therefore, show an insurance expense of $2,500 under the line item of Insurance Expense. Whereas, in the company’s balance statement, the closing balance of the current prepaid insurance account will show a balance of $7,500 ($10,000- $2,500) for the quarter ending.

Last Updated on November 3, 2023 by Nansel Nanzip Bongdap