It is included as a current asset on the balance sheet of the company and the amount of prepaid insurance that is included is the one which is unexpired insurance as of the date on which, the balance sheet is being prepared. In the business, the company usually needs to make an advance payment for the insurance that it has purchases. retained earnings In this case, it is important for the company to record the payment as prepaid insurance. Prepaid expenses are recorded as an asset on a company’s balance sheet because they represent future economic benefits.
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- This method is generally what is shown in textbooks as it most closely follows the theory of why we record prepaid expenses.
- On 01 Jan, the company make journal entry debiting prepaid insurance $ 12,000 and credit cash $ 12,000.
- On 01 Jan, company ABC purchase the insurance cost $ 12,000 from the insurance company.
- These prepayments represent economic resources that will provide future benefits to the company.
- Notice that the amount for which adjustment is made differs under two methods, but the final amounts are the same, i.e., an insurance expense of $450 and prepaid insurance of $1,350.
On 01 Jan, company ABC purchase the insurance cost $ 12,000 from the insurance company. On December 31, a prepaid expense is created to reduce the insurance expense for the amount of the $10,000 premium that is for coverage next year, January 1 through September 30—or 75%. In this case, Prepaid Insurance is classified as current assets on the Balance Sheet, as shown below. The trial balance, drawn up on 31 December 2019, assumed that he had no other insurance and his insurance expenses account would show a balance of $4,800.
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Pros & Cons of Prepaid Expenses
Prepaid insurance is nearly always classified as a current asset on the balance sheet, since the term of the related insurance contract that has been prepaid is usually for a period of one year or less. If the prepayment covers a longer period, then classify the portion of the prepaid insurance that will not be charged to expense within one year as a long-term asset. Prepaid insurance is commonly recorded, because insurance providers prefer to bill insurance in advance. If a business were to pay late, it would be at risk of having its insurance coverage terminated. The company pays the insurance fees in advance, it cannot record it as an expense yet. The main advantage of prepaid insurance is that companies occasionally pay bills in advance to gain a discount.
- In each of the successive months, equal parts insurance will continue to be credited from the prepaid insurance account.
- The prepaid insurance is an asset of the business and is shown on the balance sheet under current assets, it is something the business has paid for but not yet used.
- She has owned Check Yourself, a bookkeeping and payroll service that specializes in small business, for over twenty years.
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- Prepaid insurance is nearly always classified as a current asset on the balance sheet, since the term of the related insurance contract that has been prepaid is usually for a period of one year or less.
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. At the payment date of prepaid insurance, the net effect is zero on the balance sheet; and there is nothing to record in the income statement. However, after adjusting entry at the end of the period for the insurance expense, the asset account will decrease while the expense account will increase.
On 01 Jan, the company make journal entry debiting prepaid insurance $ 12,000 and credit cash $ 12,000. In the period paid, prepaid expenses consume cash and therefore result in less cash flow than net income. When prepaid expenses are recognized, they result in lower net income than cash flow. In an indirect cash flow statement, an increase in prepaid expenses results in a negative cash flow adjustment and vice versa. The effect of the two entries combined is to show the insurance expense of $2,500 and the balance in prepaid insurance bookkeeping and payroll services of $7,500.
