Why would Prepaid Insurance have a credit balance?

Prepaid insurance is a credit to the insurance company at the time that it is made. In the previous example, the premium that is received for six months of car insurance coverage is initially recorded as a credit. When the company makes an advance payment for insurance, it can make prepaid insurance journal entry by debiting prepaid insurance account and crediting cash account.

Each of the accounts in a trial balance extracted from the bookkeeping ledgers will either show a debit or a credit balance. The normal balance of any account is the balance (debit or credit) which you would expect the account have, and is governed by the accounting equation. The normal balance sheet is vital because it offers a comprehensive look at an organization’s financial activities. This includes information on how the company handles financial affairs and the effectiveness of those measures. The balance sheet lets you analyze current income and expenses and make an appropriate plan moving forward.

Every transaction, no matter the complexity or simplicity, can be represented by this simple equation. However, the amortization of this asset only takes place once the company utilizes the said service. As the company uses the offered service, then the amount gets expenses in the Income Statement. In this case, accountants need to segregate the expenses into categories of expenses incurred in the current year and expenses that are supposed to be carried forward. Pay-per-mile car insurance policies are designed to benefit customers who maintain low annual mileage, such as people who work from home, are stay-at-home parents, or are retirees.

Time Value of Money

The landlord requires that Company A pays the annual amount ($120,000) upfront at the beginning of the year. As per the agreement with the landlord, they were supposed to pay an advance rent of 2 years (up to 31 December 2020). As mentioned earlier, Prepaid Expenses are mentioned on the Balance Sheet as a Current Asset. Other Current Asset types include Inventory, Accounts Receivable, and Cash and Cash Equivalents. This can also be considered as an alternate form of cash (or cash equivalent), where the amount has been paid to the vendor providing that service. The 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.

  • The resources a company owns are provided by either creditors or owners.
  • 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.
  • Hence, it can be seen that prepaid expenses, although different from other classes of current assets, serve the same purpose in providing the required results.
  • A contra asset account covers things such as accumulated depreciation.
  • If you keep a ledger, enter the prepaid insurance payment as both a debit and credit.

If you keep a ledger, enter the prepaid insurance payment as both a debit and credit. 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. It should be noted that if an account is normally a debit balance it is increased by a debit entry, and if an account is normally a credit balance it is increased by a credit entry. So for example a debit entry to an asset account will increase the asset balance, and a credit entry to a liability account will increase the liability.

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Thus, prepaid insurance has a debit balance just like any other asset and it is debited in the books of accounts. A prepaid expense is anexpenditurethat a bookkeeping visalia business or individual pays for before using it. When someone purchases prepaid insurance, the contract generally covers a period of time in the future.

Normal Balance and the Accounting Equation

Prepaid insurance is usually considered a current asset, as it becomes converted to cash or used within a fairly short time. But if a prepaid expense is not consumed within the year after payment, it becomes along-term asset, which is not a very common occurrence. The payment of the insurance expense is similar to money in the bank—as thatmoney is used up, it iswithdrawn from the account ineach month oraccounting period.

How is prepaid insurance recorded on the balance sheet?

But, as the benefit of the prepaid expense is realized, or as the expense is incurred, it is recognized on the income statement. It is a current asset since its benefit will be received within a year. The actual amount pertaining to the next accounting period is recorded on the asset side of the balance sheet of the current year.

Difference between Prepaid Expenses and Other Current Assets

They usually relate to the purchase of something that provides value to the business over the course of multiple accounting periods. Prepaid insurance is a future expense, which you must pay upfront and receive its benefits over time. However, once you make the premium payment, the policy’s coverage becomes an asset, which diminishes over time during the coverage period. In accounting, the total amount for liabilities must always be equal to the total amount for assets. This is because balance sheets are two different views of a singular business. Hence, it can be seen that prepaid expenses, although different from other classes of current assets, serve the same purpose in providing the required results.

For instance, you might pay $1.50 each day you drive plus $0.06 per mile. Like all financial products, prepaid insurance has both advantages and disadvantages to consider. Some insurers prefer that insured parties pay on a prepaid schedule such as auto or medical insurance. For example, on September 01, 2020, the company ABC Ltd. pays $1,200 for one year of fire insurance which covers from September 01, 2020.

For instance, many auto insurance companies operate under prepaid schedules, so insured parties pay their full premiums for a 12-month period before the coverage actually starts. The same applies to many medical insurance companies—they prefer being paid upfront before they begin coverage. A prepaid expense is an expenditure that a business or individual pays for before using it. The adjusting journal entry for a prepaid expense, however, does affect both a company’s income statement and balance sheet.

Therefore, the amount of prepaid rent that will be presented on the Balance Sheet at the year-end 31 December 2019 amounts to $2,400. This is going to be represented as Prepaid Rent under the Current Assets. During the ordinary course of business, several transactions are taking place over the course of time, which is not really consistent with the amount of expenses incurred during that time frame. Insurance companies often offer incentives to customers who prepay their premiums, but this type of plan requires making a large lump-sum payment. Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries.

For example, the $1,200 prepaid policy will reduce in value by $100 each month, which you adjust in your ledger. Prepaid insurance is insurance paid in advance and that has not yet expired on the date of the balance sheet. By its definition, an asset is considered resource resourceful for the organization since it helps render profits shortly. Current Assets are assets that are likely to provide an incentive to the company within 12 months. Prepaid Expenses are expenses that have been paid in advance, whereas accrued expenses are expenses that the organization owes.

Individuals benefit from prepaid expenses to make sure they will not miss payments for things like health insurance. The adjusting journal entry is done each month, and at the end of the year, when the lease agreement has no future economic benefits, the prepaid rent balance would be 0. When there is a payment that represents a prepayment of an expense, a prepaid account, such as Prepaid Insurance, is debited and the cash account is credited. This records the prepayment as an asset on the company’s balance sheet. Prepaid rent is a rent paid in advance so it is current asset
and it will have debit balance as normal balance.

Prepaying your insurance premium might complicate the cancellation process. For example, if you pay your $1,500 annual home insurance premium in one payment, then sell your house six months into the policy’s term, the insurer will have to refund the unused premium. Although providers do issue prorated refunds, you may have to wait days or weeks to receive the money.

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