Prepaid Expenses Examples, Accounting for a Prepaid Expense

Because of how certain goods and services are sold, most companies will have one or more prepaid expenses. For example, the purpose of insurance is to buy proactive protection for the future. No insurance company would sell insurance that covers a past event, so insurance expenses must be prepaid by businesses. A prepaid expense is an asset on a balance sheet that results from a business making advanced payments for goods or services to be received in the future. Assume that Bill’s Retail Store pays its liability insurance premiums every six months.

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Enter the monthly expense for each accounting period

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• Companies use two sets of journal entries to record the insurance-related transactions, involving both prepaid insurance and expired insurance.
• Insurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe.
• Essentially, prepaid insurance is an asset till the insurance premium expires.
• BlackLine products work in unison to eliminate manual spreadsheet-dependent processes prone to human error.
• FastTrack company buys one-year insurance for its delivery truck and pays $1200 for the same on December 1, 2017.

To create your first journal entry for prepaid expenses, debit your Prepaid Expense account. This account is an asset account, and assets are increased by debits.

Why Are Prepaid Expenses Assets?

For example, because of recent legal issues, Jill puts her attorney on retainer. Though she pays the retainer in full, Jill still needs to determine how much she will need to expense each month as the retainer is used. The spreadsheet would continue through December, displaying the amount that will need to be expensed each month. The asset is converted to an expense for the period in which the prepaid is used. ParticularsDebitCreditInsurance prepaid insurance journal entry Expense A/c$2,000 To Prepaid Insurance A/c$2,000The income statement for the quarter ending will show an expense of $2,000 under the line item of Insurance Expense. Companies come to BlackLine because their traditional manual accounting processes are not sustainable. We help them move to modern accounting by unifying their data and processes, automating repetitive work, and driving accountability through visibility.

• After that period, the insurance premium may expire, converting it to an expense.
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• The product then automatically amortizes the expense over future periods, eliminating the need to manage spreadsheets or other manual tracking systems.

Consider the previous example from the point of view of the customer who pays $1,800 for six months of insurance coverage. Initially, she records the transaction by increasing one asset account with a debit and by decreasing another asset account with a credit. After one month, she makes an adjusting entry to increase insurance expense for $300 and to decrease prepaid insurance for $300. Companies record this asset under current assets on the balance sheet. After that period, the insurance premium may expire, converting it to an expense.

Related to Closing Prepaid Expenses

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Prepaid Expenses Accounting Examples

Therefore, the unexpired portion of this insurance will be shown as an asset on the company’s balance sheet. 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. A prepaid expense is an expenditure that a business or individual pays for before using it. When someone purchases prepaid insurance, the contract generally covers a period of time in the future.

Prepaid expenses only turn into expenses when you actually use them. The value of the asset is then replaced with an actual expense recorded on the income statement. In small business, there are a number of purchases you may make that are considered prepaid expenses. When the insurance coverage starts or the rent period begins, the company will start expensing the prepaid amount. The expensing is usually done over the term of the insurance coverage or rent on a straight-line basis. However, note that other methods of amortization (different from straight-line) are also applied.