For example, if a business had purchased six months of insurance and decided to cancel the policy after two months, it could redeem the value of the four remaining unused months of coverage. In this way, prepaid insurance has economic value, not unlike an investment in stocks or bonds, that can be redeemed at a later time. A premium is a regular, recurring payment made to a provider for the benefit of having insurance coverage. When the insurance coverage comes into effect, it is moved from an asset and charged to the expense side of the company’s balance sheet. In this case, the company’s balance sheet may show corresponding charges recorded as expenses. Accounting accrued expenses are the expenses that are incurred before they are paid.

• Navigating the differences between International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) can be challenging, especially regarding prepaid insurance.
• Insurance expense, as an expense is treated in the same way as other expenses that are incurred.
• And the company is usually required to pay an insurance fees for one year or more in advance.
• It is considered a prepaid asset, which is a way to express these benefits in accounting terms.
• Before we dive into the definition and examples of accounting prepaid expenses, let’s clarify the difference between accounting prepaid expenses and accounting accrued expenses.

Recognition of expenses

Such adjustments are critical for maintaining accurate financial records and ensuring compliance with accounting standards. Adjusting entries are made to reflect the consumption of prepaid insurance over time. This process aligns expense recognition with the period in which the insurance coverage is consumed. The prepaid insurance expense account under the recording transactions current assets in the balance sheet will still show the amount of $16,000. In each of the successive months, equal parts insurance will continue to be credited from the prepaid insurance account.

Accounts Payable Solutions

After making the entry, the balance of the unused Service Supplies is now at $600 ($1,500 debit and $900 credit). Since adjusting entries involve a balance sheet account and an income statement account, it is wise to monitor the balances in both Prepaid Insurance and Insurance Expense throughout the year. As the policy is consumed from month to month, the policy’s value for those months will be recorded as a credit, and the entries in the two columns will eventually cancel out or total zero. Without prepaid insurance, you would have to bear the full financial burden of repairing or replacing the machinery. However, with prepaid insurance, you were able to protect your business and ensure that you could continue operating without significant disruption. Based on this, the first component is the current year’s expense, since it is relevant to the timeline for which the financial statements are being prepared.

Where does prepaid insurance go on a balance sheet?

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. A company’s property insurance, liability insurance, business interruption insurance, etc. often covers a one-year period with the prepaid insurance is cost (insurance premiums) paid in advance.

But, at the end of the financial year, this would then be carried down to the next year, as a prepaid expense. In the case where there are payments that need to be made by the organization to the suppliers (or service providers), it is regarded as a Current Liability in the Balance Sheet. Alternatively, if the organization has paid in advance for a particular service, it is disclosed as a Current Asset. In this way, the asset value of the prepaid insurance will be reduced to zero at the end of the time period which was paid for in advance. Similarly, the expense will reach Coffee Shop Accounting the total of the prepaid amount at the end of that same period. Any remaining prepaid portion of the premium could be redeemed or refunded to the business if the business cancels the policy before the period covered by those premiums has expired.