Likewise, the adjusting entry at the end of the period is necessary for the company to recognize the cost that expires through the passage of time. 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. Then, over the next two years, the remaining $4,000 amount would be transferred to insurance expenses by preparing similar year-end adjustments at the end of 2023 and 2024.
What are the adjusting entries for prepaid insurance? (Example and Explanation)
- As the prepaid amount expires, the balance in Prepaid Insurance is reduced by a credit to Prepaid Insurance and a debit to Insurance Expense.
- The matching principle is the basis for allocating expenses to the periods in which they are used or consumed.
- When the financial statements are to be audited by the company’s auditors, it is very necessary to make the required year-end adjusting entries.
- Therefore, the unexpired portion of this insurance will be shown as an asset on the company’s balance sheet.
Then, when the expense is incurred, the prepaid expense account is reduced by the amount of the expense, and the expense is recognized on the company’s income statement in the period when it was incurred. Prepaid expenses are payments for goods or services that will be received in the future. These expenses are not initially recorded on a company’s income statement for the period when the money changes hands. 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.
- Note that before the adjusting entry for prepaid insurance is made, the dollar equivalent of the portion of insurance that has expired has to be determined.
- Deferrals are adjusting entries for items purchased in advance and used up in the future (deferred expenses) or when cash is received in advance and earned in the future (deferred revenue).
- Since the Accumulated Depreciation account was credited in the adjusting entry rather than the Equipment account directly, the Equipment account balance remains at $6,000, its cost.
- The adjusting entry ensures that the amount of insurance expired appears as a business expense on the income statement, not as an asset on the balance sheet.
- At the end of April, one month of insurance coverage has been used, so XYZ Company needs to expense 1/3rd of the quarterly premium.
Journal Entries for Prepaid Insurance
- Under the accrual basis of accounting, the matching is NOT based on the date that the expenses are paid.
- Unexpired or prepaid expenses are the expenses for which payments have been made, but full benefits or services have yet to be received during that period.
- Here are the Prepaid Insurance and Insurance Expense ledgers AFTER the adjusting entry has been posted.
- The amount of a long-term asset’s cost that has been allocated to Depreciation Expense since the time that the asset was acquired.
- Under the accrual basis of accounting, revenues are recorded at the time of delivering the service or the merchandise, even if cash is not received at the time of delivery.
- This prepaid account will come to the NIL balance at the end of the accounting period and all the expenses accrued in the income statement.
Because they represent a future benefit owed to the Bookstime company, companies list prepaid expenses first on the balance sheet in the prepaid asset account. Because companies anticipate them to be consumed, employed, or spent through regular business activities within a year. The amount of insurance that was incurred/used up/expired during the period of time appearing in the heading of the income statement. The amount of insurance premiums that have not yet expired should be reported in the current asset account Prepaid Insurance. Further, the company has a liability or obligation for the unpaid interest up to the end of the accounting period.
Prepaid Insurance Journal Entry
As time passes and the insurance coverage is used, an adjusting entry is made to expense the portion of the prepaid insurance that has been used. For our next example, let’s look at depreciation as an example of year-end adjusting entries. Long-term assets such as equipment and buildings will render productive benefits over a period of time. Hence, a portion of their cost has to be allocated to each period by reporting depreciation expense. One simple method that is used for prepaid insurance adjusting entry depreciation expense calculation is the straight-line method, where an equal amount of the cost of an asset is assigned to each year of the asset’s useful life. This means the company should record the insurance expense at the period end adjusting entry when a portion of prepaid insurance has expired.
Examples of Two Methods for Recording Prepaid Expenses
The ending balances in the income statement accounts (revenues and expenses) are closed after the year’s financial statements are prepared and these accounts will start the next accounting period with zero balances. The company must continue to make appropriate journal entries to apportion the prepaid insurance expense according to the time period during which the expense will continue to accrue. This is usually done by the accounting department at the end of each financial year by using an adjusting journal entry. In the world of accounting, prepaid expenses are a common occurrence, particularly with insurance payments.
What is the difference between prepaid assets and deferred revenue?
This amount is still an asset to the company since it has not been used yet. For instance, a year-end adjusting normal balance entry can be made to reclassify a portion of an amount due under a long-term debt arrangement as a short-term debt, since it is due and payable within one year. Also, year-end adjusting entries may be required if outside auditors discover any error. For instance, assume auditors discover that the ending inventory is overstated by $20,000, they would request that a year-end adjusting entry is made to correct this error.