It’s only insurance companies, with the need to have pristine financial statements, that need to make sure every dollar is accounted for. For these businesses, any unused insurance that’s been received but haven’t expired count as an asset. While prepayment and monthly billing are standard ways to pay an insurance premium, some auto insurance companies offer pay-per-mile policies. You must pay prepaid expenses upfront before you receive any type of benefit. For example, you might buy a one-year magazine subscription and receive one magazine per month for 12 months. As prepaid insurance is an asset that will expire through the passage of time, the cost of expiration will need to be recognized as an expense during the period.

• More than 4,300 companies of all sizes, across all industries, trust BlackLine to help them modernize their financial close, accounts receivable, and intercompany accounting processes.
• A company spending six or seven figures a year on insurance costs will want to count that cash as an asset until it’s actually used.
• Counting an asset that amounts to less than a week or two of my salary (and continues to drop) won’t make a difference in the grand scheme of things.

Energize your accounting team by creating capacity with automation. Drive visibility, accountability, and control across every accounting checklist. Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years. He is the sole author of all the materials on AccountingCoach.com. I do keep track of my net worth so I have a rough indication of how much wealth I’ve accumulated over the years. Counting an asset that amounts to less than a week or two of my salary (and continues to drop) won’t make a difference in the grand scheme of things.

Alternative Approach to Prepaid Insurance Classification

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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. A common financial question we see asked is related to prepaid insurance. Prepaid insurance is exactly what it sounds like – insurance that’s been prepaid. Just pay the bill when it arrives, then rest easy knowing that you’re protected.

What is prepaid insurance an example of? ›

Each month, the business’s accounting department would make an adjusting journal entry of $1,000, representing the amount of one month’s premium payment in the general ledger. It would be entered as a credit in the asset account and as a debit to the insurance expense account. On December 31, anadjusting entrywill show a debit insurance expense for $400—the amount that expired or one-sixthof $2,400—and will credit https://personal-accounting.org/prepaid-insurance-definition/ for $400.

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Effect of Prepaid Expenses on Financial Statements

The concept of prepaid is not used in the cash method of accounting, which is most often used by small businesses. Prepaid insurance also creates other benefits for the business. It is considered a prepaid asset, which is a way to express these benefits in accounting terms. More than 4,300 companies of all sizes, across all industries, trust BlackLine to help them modernize their financial close, accounts receivable, and intercompany accounting processes. The revenue cycle refers to the entirety of a company’s ordering process from the time an order is placed until an invoice is paid and settled. The inability to apply payments on time and accurately can not only lock up cash, but also negatively impact future sales and the overall customer experience.

Understanding Goodwill in Balance Sheet – Explained

In the subsequent year, when insurance is lapsed, then the amount will be deducted as an expense from the Income Statement. In the case where there are payments that need to be made by the organization to the suppliers (or service providers), it is regarded as a Current Liability in the Balance Sheet. Alternatively, if the organization has paid in advance for a particular service, it is disclosed as a Current Asset. Pollution, mold, asbestos and bacterial contamination can all leave companies owing millions of dollars in costs related to lawsuits and cleanup requirements. In this way, the asset value of the prepaid insurance will be reduced to zero at the end of the time period which was paid for in advance. Similarly, the expense will reach the total of the prepaid amount at the end of that same period.

In contrast, a non-current or fixed asset, like real estate, cannot be easily liquidated in a year or less. Defining Deferred Revenue and Deferred Expenses Deferred expenses, similar to prepaid expenses, refer to expenses that have been paid but not yet incurred by the business. Common prepaid expenses may include monthly rent or insurance payments that have been paid in advance. 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.