Is Prepaid Insurance an Asset?

Fifteen years after its fire-sale purchase of Lehman Brothers’ core assets jump-started its investment-banking business, the British lender is still trying to find its footing. GAAP is the short form for generally accepted accounting principles. These are a set of rules and regulations that revolve around various accounting concepts. It includes details of legalities of business, complexities, and legalities of corporate business.

Therefore, it should be recorded as a prepaid expense and allocated out to expense over the full twelve months. When we are making the balance sheet, it has been made clear that prepaid expenses will be recorded as an asset on the debit side of the sheet. The equations explain that assets are equal to liability and equity. Now, when making the accounting equation, the prepaid insurance amount is credited from the assets and debited in the liability. Advantages of prepaid insurance include being able to budget for insurance premiums in advance, which can help businesses to manage their cash flow. Prepaying for insurance also helps businesses save money, as insurance companies often offer discounts on premiums paid in advance.

An Exception to the Current Asset Rule

The insurance fees paid per year might however change with time, this is usually a result of inflation or other factors in insurance. The insurance company will however inform their clients of any changes in the amount to be paid prior to subsequent payments. Companies that have experienced an accident on the item insured can file an insurance claim. Additionally, they may cancel their subscription and discontinue the insurance contract. It’s common to classify prepaid insurance as a current asset because you can convert it to cash or use it within short periods. It is done specifically from the customer’s account at the end of the accounting period.

In this case, assuming that the service represented by the asset expires equally each month, the Prepaid Insurance account must be reduced by $900. The matching convention requires allocation of the expenditure between the asset that represents the remaining economic benefits and the expense that represents the benefits used or consumed by the firm. For prepaid policies, you submit a claim, and the policyholder often renews them soon before their expiration date under similar circumstances to their original contract.

Accounting Steps to Record Prepaid Insurance

Maximize working capital with the only unified platform for collecting cash, providing credit, and understanding cash flow. Transform your accounts receivable processes with intelligent AR automation that delivers value across your business. Prepaid insurance isn’t an intangible asset; it falls under a company’s prepaid asset classification.

Prepaid Insurance Journal Entry Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract. As the amount of prepaid insurance expires, the expired portion is moved from the current asset account Prepaid Insurance to the income statement account Insurance Expense. This is usually done at the end of each accounting period through an adjusting entry.

Effect of Prepaid Expenses on Financial Statements

An asset is an economic resource that provides future benefits for the business. Prepaid expenses are assets that are paid in cash in advance and have benefits that apply over future periods. Prepaid insurance impacts the financial reports of a company, including the balance sheet, cash flow, profit, and loss statements.

When the numbers get high enough, you can understand why this matters. 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. In theory, they could cancel the insurance early and receive a huge cash refund. The term prepaid insurance refers to payments that are made by individuals and businesses to their insurers in advance for insurance services or coverage.

This helps to maximize the financial benefits of prepaid insurance. This article seeks to analyze whether prepaid insurance is actually an asset and its benefits to businesses. We will also explore how prepaid insurance is recorded in accounting, how it is taxed, and how it depreciates. 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. Technically, we can argue that prepaid insurance counts as an asset for individuals too.

Prepaid Expense: Definition and Example

It will specifically be recorded as a current asset since it will be used up within one year. In rare instances, companies could make a prepaid insurance payment that gives them insurance coverage for more than one year. When this happens, the insurance balance that will be used up in subsequent years is recorded as a non-current asset. After this first expense, your balance sheet will show that there is $1,100 left in your prepaid insurance account. Eventually, there will be zero dollars left in the prepaid insurance account because the policy term is over. You can then choose to prepay for insurance again and this process will repeat.

Furthermore, some insurance companies may charge a cancellation fee when a client chooses to cancel their subscription and discontinue using the insurance company’s services. When the insurance premium payment is ordinarily due, that expense is deducted from the asset side and moved to the expense side. The entire cost of prepaid insurance is recorded on the asset side and is then amortized over the policy term. The $4,000 expenditure will appear as an adjustment to income on the income statement, and on the balance sheet, a $4,000 reduction will appear in the prepaid expense asset account. During this period, prepaid insurance of $5,000 from the previous period expired.

What Is Prepaid Insurance?

If you pay a six-month premium for a car insurance policy, the coverage will protect your automobile from the effective date until it’s time to renew the policy. You must pay prepaid expenses upfront before you receive any type of benefit. For example, what are payroll taxes you might buy a one-year magazine subscription and receive one magazine per month for 12 months. The expense would show up on the income statement while the decrease in prepaid rent of $10,000 would reduce the assets on the balance sheet by $10,000.

• 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.
• Instead, prepaid expenses are first recorded on the balance sheet; then, as the benefit of the prepaid expense is realized, or as the expense is incurred, it is recognized on the income statement.
• Key Takeaways Prepaid insurance is a current asset if coverage is used within one year of payment.
• Prepaid expenses are assets that are paid in cash in advance and have benefits that apply over future periods.

Essentially, the policyholder receives a form of protection against a specific event or loss. However, the IRS also has rules for when a business can claim deductions for prepaid expenses. According to IRS publications 535 and 463, businesses can either deduct prepaid expenses when incurred or when they benefit from the expense. For instance, businesses must keep track of when the prepaid insurance will expire so that they can renew it before it runs out. Additionally, businesses could face a loss if they forget to renew the prepaid insurance on time and experience a loss during the period in which they don’t have insurance coverage. It is an Asset that a company records on its balance sheet as the expense is paid in advance.

Video: Prepaid insurance as an asset

As the insurance will not be used until and unless the first quarter of next year arrives, it will be reflected under the Asset side of the company as prepaid insurance. It will be shown as an expense when the 1st quarter of next year arrives. 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. 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.

• A prepaid asset is a type of asset that has economic value to the business because of its future benefit.
• The liabilities on the other hand will be representing the obligations of the company.
• If you pay a six-month premium for a car insurance policy, the coverage will protect your automobile from the effective date until it’s time to renew the policy.
• When an expense is paid in advance, the company will not have to pay it when it arises.
• At this point, the insurance premium has not reached maturity and is unexpired.

At this point, the insurance premium has not reached maturity and is unexpired. Once the amount expires, companies must move it to the insurance expense account in the income statement. Prepaid insurance refers to the insurance premium paid before their insurance term. It is an asset that companies record to recognize the future coverage they will receive from the contract. In accounting, prepaid insurance records the insurance premium that hasn’t expired at the reporting date. Any portion of the amount used during the period becomes an expense for the company.