Why Is Prepaid Insurance Considered an Asset?

Now, we already understood the key definitions of prepaid expenses and amortization. Let’s go further about different types of prepaid expenses that we commonly see. If you opt to make monthly installments, expect to pay $125-$300 per month, depending on the total cost, age, and installment period. Similar to the cost of funerals in general, the cost of a funeral preplan is heavily influenced by your preferences, age, and region. During unearned revenue the 12-month waiting period for graded coverage, you would receive a refund equal to all the payments you’ve made (plus interest). The remaining 30% could still be paid out, but that is subject to the outcome of the contestability clause.

Understanding Goodwill in Balance Sheet – Explained

• This can be a challenge, particularly if the company has to make monthly payments.
• While prepaid insurance is recorded as an asset on the balance sheet when it is paid, it becomes an expense on the income statement as the insurance is consumed.
• Thus, out of the $1,500, $900 worth of supplies have been used and $600 remain unused.
• So, buckle up, because we’re about to dive into the nitty-gritty of prepaid insurance journal entries with some down-to-earth examples.
• Each month, as a portion of the prepaid premiums are applied, an adjusting journal entry is made as a credit to the asset account and as a debit to the insurance expense account.

In simple terms, prepaid insurance is the money you pay upfront to your insurance company before you get to enjoy any of their coverage. It’s like paying for your streaming subscription a year in advance—except instead of binge-watching shows, you’re safeguarding your business. This amount hasn’t been used yet because the coverage period is still ongoing. In your books, prepaid insurance is treated as an asset, and you gradually charge it to expense prepaid insurance over the duration of the insurance contract.

Insurance Expense Recognition

The adjusting entry for prepaid expense depends upon the journal entry made when it was initially recorded. Prepaid Insurance Journal Entry Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract. The prepaid insurance will be recorded when the company makes payment to the insurance company. Assume that a company’s annual premium on its liability insurance policy is $2,400 and is due on the first day of each year.

What is the difference between prepaid expenses and advance payment?

Prepaid insurance reduces the administrative burden for policyholders, making it easier to manage their coverage. For the past 52 years, Harold Averkamp (CPA, MBA) hasworked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. The insurance used for December will be reported as an Insurance Expense on December’s income statement. Let us look at the balance sheet at the end of one month on December 31, 2017. Some insurers prefer that insured parties pay on a prepaid schedule such as auto or medical insurance.

Characteristics of Prepaid Insurance as an Asset

• Master the fundamentals of financial accounting with our Accounting for Financial Analysts Course.
• A cornerstone of adept financial management is the accurate recording and tracking of prepaid insurance.
• Prepaid insurance is one of the topics related to asset recognition, expense allocation, and adjusting entries for CFA Level I Financial Reporting.
• This protection extends to claims filed during the covered period, regardless of when the premium was paid.
• If you currently have a life insurance policy, the proceeds from it can certainly be used for your funeral costs.
• A prepaid expense by definition is an expense that has been paid for by the business in advance, that is, before the services for that expense have been availed.

For example, a $12,000 one-year policy starting January 1 requires a $1,000 monthly adjustment. The adjusting entry for prepaid expense will depend upon the initial journal entry, whether it was recorded using the asset method or expense method. If you currently have a life insurance policy, the proceeds from it can certainly be used for your funeral costs. Double-check your account to see how much coverage you have to ensure it will provide enough payout to cover your desired services. The total payment for the insurance policy is recorded as a prepaid asset in the balance sheet.

Changes in business operations, risk exposure, or policy terms can result in prepaid insurance coverage a company no longer needs. Adjusting for unused coverage requires reassessing the prepaid balance to ensure financial statements reflect the remaining value. If a policy is canceled early, insurers typically Liability Accounts issue a prorated refund based on the unused portion of the premium. However, some policies include short-rate cancellation penalties, reducing the refund amount to account for administrative costs and early termination risks. Understanding the insurer’s refund calculation method is necessary to determine the correct adjustment amount.