Prepaid expenses are recorded first on the balance sheet—in the prepaid asset account—because it represents a future benefit due to the business. Prepaid expenses are considered a current asset because they are expected to be consumed, used, or exhausted through standard business operations with one year. The main advantage of prepaid insurance is that companies occasionally pay bills in advance to gain a discount. A business may gain from prepaid expenses by avoiding the need to make payments for upcoming accounting periods. On December 31, an adjusting entry will show a debit insurance expense for $400—the amount that expired or one-sixth of $2,400—and will credit prepaid insurance for $400.

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What Is the Process for Reporting Prepaid Expenses?

An organization makes a cash payment to the leasing company, but the rent expense has not yet been incurred, so the company must record the prepaid rent. Prepaid rent is an asset because the prepaid amount can be used in the future to reduce rent expense when incurred. To illustrate prepaid insurance, let’s assume that on November 20 a company pays an insurance premium of $2,400 for insurance protection during the six-month period of December 1 through May 31. On November 20, the payment is entered with a debit of $2,400 to Prepaid Insurance and a credit of $2,400 to Cash.

When the prepaid expense balance increases, that means the company has a cash outflow for expenses that have not yet been recognized in the income statement. An example that you might see on the CPA exam might indicate that if the company prepays rent for 12 months, the prepaid rent balance will increase for the… If nothing is prepaid, then the https://www.bookstime.com/ account must be a zero balance. If an insurance premium is owing to the insurance company then there would be a liability account with a credit balance for the amount owed as of the balance sheet date. Whatever the cause of the credit balance in the prepaid insurance account, the account needs to be switched to a liability or zeroed out by making payment before issuing a balance sheet. In most cases, prepaid insurance is listed as an asset on the insurance company’s balance sheet.

Example of Prepaid Insurance

It reflects the strong earning power of the company and creates goodwill in the market. Companies that take care of assets and employees by paying reasonable advance insurance premiums are considered strong financial companies. There should always be a check regarding the period for advance in insurance. A company shouldn’t advance too much as it may reflect badly on the profitability. This is because the company has paid an expense in advance, which will help to ease the expense later. As the expense is paid beforehand, it is treated as a prepaid expense and recorded accordingly. Yearly accounting of a company is done as per financial year, so it is treated as an asset if insurance expense for the next financial year is already paid this year.

Page, search and select the expense type for which you want to allow prepaid expenses. Employees can enter the prepaid expenses in the expense report for these expense types by selecting this check box.

Prepaid Expenses Definition in Accounting

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While prepayment and monthly billing are standard ways to pay an insurance premium, some auto insurance companies offer pay-per-mile policies. Throughout the home insurance policy’s term, you will reduce the value of the asset. For example, the $1,200 prepaid policy will reduce in value by $100 each month, which you adjust in your ledger. XYZ company needs to pay its employee liability insurance for the fiscal year ending December 31, 2018, which amounted to $10,000. The company has paid $10,000 of the insurance premium for the entire year at the beginning of the first quarter. There are numerous adjustment entries as well as different types of journal entries for prepaid insurance. It avoids the need for pointless new business transaction entries.