Prepaid Insurance Journal Entry Example

In the previous chapter, tentative financial statements were prepared directly from a trial balance. However, a caution was issued about adjustments that may be needed to prepare a truly correct and up-to-date set of financial statements. In other words, the ongoing business activity brings about changes in account balances that have not been captured by a journal entry. Time brings adjusting entry for prepaid insurance about change, and an adjusting process is needed to cause the accounts to appropriately reflect those changes. These adjustments typically occur at the end of each accounting period, and are akin to temporarily cutting off the flow through the business pipeline to take a measurement of what is in the pipeline. This is consistent with the revenue and expense recognition rules.

As each month passes, the Accumulated Depreciation account balance increases and, therefore, the book value decreases. The $100 balance in the Taxes Expense account will appear on the income statement at the end of the month. The remaining $1,100 in the Prepaid Taxes account will appear on the balance sheet.

If Laura does not accrue the revenues earned on January 31, she will not be abiding by the revenue recognition principle, which states that revenue must be recognized when it is earned. During the month you will use some of these supplies, but you will wait until the end of the month to account for what you have used. On the other hand, liabilities, equity, and revenue are increased by credits and decreased by debits. Company A signs a one-year lease on a warehouse for $10,000 a month. The landlord requires that Company A pays the annual amount ($120,000) upfront at the beginning of the year. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more.

  1. To transfer what was used, Supplies Expense was debited for the amount used and Supplies was credited to reduce the asset by the same amount.
  2. Examples are equipment, furnishings, vehicles, buildings, and land.
  3. In the business, the company usually needs to make an advance payment for the insurance that it has purchases.
  4. This future benefit is in the form of the insurance coverage that the company gets for the period covered by the prepayment.

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. Most prepaid expenses appear on the balance sheet as a current asset unless the expense is not to be incurred until after 12 months, which is rare.

A business license is a right to do business in a particular jurisdiction and is considered a tax. There are two ways this information can be worded, both resulting in the same adjusting entry above. During the month you will use some of this rent, but you will wait until the end of the month to account for what has expired. During the month you will use some of this insurance, but you will wait until the end of the month to account for what has expired. Here are the ledgers that relate to the purchase of supplies when the transaction above is posted.

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(Notice in the journal entry above that the debit account is “Equipment,” NOT “Equipment Expense”). Fixed assets are first recorded as assets that later are gradually “expensed off,” or claimed as a business expense, over time. The $1,500 balance in the asset account Prepaid Insurance is the preliminary balance.

As each month passes, adjust the accounts by the amount of rent you use. Since the prepayment is for six months, divide the total cost by six ($9,000 / 6). Consequently, at the end of the month of January, when the company wants to record the insurance expense for the month, they will need to divide the amount paid ie.

Prepaid expenses are payments made in advance for goods or services that will be received or used in the future. Notice that the amount for which adjustment is made differs under two methods, but the final amounts are the same, i.e., an insurance expense of $450 and prepaid insurance of $1,350. The trial balance, drawn up on 31 December 2019, assumed that he had no other insurance and his insurance expenses account would show a balance of $4,800.

In order to account for that expense in the month in which it was incurred, you will need to accrue it, and later reverse the journal entry when you receive the invoice from the technician. There are two changes that will be made so that the journal entry is CORRECT for depreciation. Here are the ledgers that relate to the purchase of prepaid taxes when the transaction above is posted. Here is the Taxes Expense ledger where transaction above is posted. Here is the Rent Expense ledger where transaction above is posted.

Example of Prepaid Insurance Journal Entry

Whether you’re posting in manual ledgers, using spreadsheet software, or have an accounting software application, you will need to create your journal entries manually. For the next six months, you will need to record $500 in revenue until the deferred revenue balance is zero. The premium covers twelve months from 1 September 2019 to 31 August 2020, i.e., four months of 2019 and eight months of 2020. It would be incorrect to charge the whole $4,800 to 2019’s profit and loss account. The word “expense” implies that the taxes will expire, or be used up, within the month. An expense is a cost of doing business, and it cost $100 in business license taxes this month to run the business.

What are prepaid expenses?

Common types of adjusting entries are depreciation and accrual of interest expense. Prepaid insurance is the portion of an insurance premium that has been paid in advance and has not expired as of the date of a company’s balance sheet. This unexpired cost is reported in the current asset account Prepaid prepaid insurance journal entry Insurance. The adjusting journal entry is done each month, and at the end of the year, when the insurance policy has no future economic benefits, the prepaid insurance balance would be 0. The main advantage of prepaid insurance is that companies occasionally pay bills in advance to gain a discount.

Step 2: Recording accrued expenses

Assets and expenses are increased by debits and decreased by credits. Suppose at the end of the month, 60% of the supplies have been used. Thus, out of the $1,500, $900 worth of supplies have been used and $600 remain unused. The $900 must then be recognized as expense since it has already been used. For example, on September 01, 2020, the company ABC Ltd. pays $1,200 for one year of fire insurance which covers from September 01, 2020. This article is not intended to provide tax, legal, or investment advice, and BooksTime does not provide any services in these areas.

The purpose of adjusting entries is to ensure that your financial statements will reflect accurate data. Prepaid expenses are recorded as an asset on a company’s balance sheet because they represent future economic benefits. After 60 months, the balance in the Accumulated Depreciation account is $6,000 and therefore the equipment is fully depreciated and has no value. After the asset is fully depreciated, no further adjusting entries are made for depreciation no matter how long the company owns the asset. Let’s assume that a review of the accounts receivables indicates that approximately $600 of the receivables will not be collectible.

Interest paid in advance may arise as a company makes a payment ahead of the due date. Meanwhile, some companies pay taxes before they are due, such as an estimated tax payment based on what might come due in the future. Other less common prepaid expenses might include equipment rental or utilities. When you initially record a prepaid expense, record it as an asset. Similarly, a prepaid insurance expense is a prepaid expense that has been paid for by the company.