How to record prepaid insurance
In the business, the company usually needs to make an advance payment for the insurance that it has purchases. In this case, it is important for the company to record the payment as prepaid insurance.
Prepaid insurance is an asset account on the balance sheet, in which its normal balance is on the debit side. The company should not record the advance payment as the insurance expense immediately. This is due to, under the accrual basis of accounting, the expense should only be recorded when it occurs.
The insurance expense incurs throughout the passage of time. This means the company should record the insurance expense at the period end adjusting entry when a portion of prepaid insurance has expired.
Record prepaid insurance with journal entry
The company can record the prepaid insurance with the journal entry of debiting the prepaid insurance account and crediting the cash account.
In this journal entry, the company records the prepaid insurance as an asset since it is an advance payment which the company has not incurred the expense yet.
As the prepaid insurance expires throughout the passage of time, the company needs to transfer the prepaid insurance that has expired in the period to the insurance expense.
Likewise, the journal entry for the insurance expense that is converted from the expiration cost of prepaid insurance is the debit of the insurance expense account and the credit of the prepaid insurance account.
Prepaid insurance example
For example, on December 18, 2020, the company ABC make an advance payment of $6,000 for the fire insurance that it purchase to cover the whole year of 2021.
In this case, the company ABC can record the prepaid insurance of $6,000 on December 18, 2020, with the journal entry below:
Later, the company ABC can record the insurance expense on the adjusting entry date of January 31, 2021, by converting the expired portion of prepaid insurance to the insurance expense with journal entry below:
In this journal entry, the $500 (6,000 / 12) of insurance expense is the expired cost of insurance in January 2021.