Content
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. 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.
- There are two ways this information can be worded, both resulting in the same adjusting entry above.
- This is usually done at the end of each accounting period through an adjusting entry.
- Therefore the account Accumulated Depreciation – Equipment will need to have an ending balance of $9,000.
- 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.
- The “Service Supplies Expense” is an expense account while “Service Supplies” is an asset.
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. And it reports accumulated depreciation in the balance sheet as a deduction from the related asset. 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 above is made at the end of each month for 60 months.
Examples of journal entry for prepaid insurance
The company usually purchases insurance to protect itself from unforeseen incidents such as fire or theft. And the company is usually required to pay an insurance fees for one year or more in advance. In this case, it needs to account for prepaid insurance by properly making journal entries in order to avoid errors that could lead to misstatement on both balance sheet and income statement. An adjusting entry is made at the end of the period to reflect the correct value of revenue and expenses for the current period. The adjusting entry includes accrual and deferral adjusting entries. 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.
At the end of the month 1/12 of the prepaid insurance will be used up, and you must account for what has expired. After one month, $100 of the prepaid amount has expired, and you have only 11 months prepaid insurance journal entry adjustments of prepaid insurance left. In addition, on your income statement you will show that you did not use ANY insurance to run the business during the month, when in fact you used $100 worth.
What is prepaid insurance?
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. 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.
Here is an example of the Prepaid Insurance account balance at the end of October. Repeat the process each month until the policy is used and the asset account is empty. As a reminder, the main types of accounts are assets, expenses, liabilities, equity, and revenue. Upon signing the one-year lease agreement for the warehouse, the company also purchases insurance for the warehouse. The company pays $24,000 in cash upfront for a 12-month insurance policy for the warehouse. Of the total six-month insurance amounting to $6,000 ($1,000 per month), the insurance for 4 months has already expired.
How Are Prepaid Expenses Recorded on the Income Statement?
The $25,000 balance in Equipment is accurate, so no entry is needed in this account. As an asset account, the debit balance of $25,000 will carry over to the next accounting year. The adjusting entries split the cost of the equipment into two categories. The Accumulated Depreciation account balance is the amount of the asset that is “used up.” The book value is the amount of value remaining on the asset.
The correct amount is the amount that has been paid by the company for insurance coverage that will expire after the balance sheet date. If a review of the payments for insurance shows that $600 of the insurance payments is for insurance that will expire after the balance sheet date, then the balance in Prepaid Insurance should be $600. Let’s assume that a review of the accounts receivables indicates that approximately $600 of the receivables will not be collectible. This means that the balance in Allowance for Doubtful Accounts should be reported as a $600 credit balance instead of the preliminary balance of $0. The two accounts involved will be the balance sheet account Allowance for Doubtful Accounts and the income statement account Bad Debts Expense.
This is usually done by the accounting department at the end of each financial year by using an adjusting journal entry. The income statement for the quarter ending will, therefore, show an insurance expense of $2,500 under https://www.bookstime.com/articles/what-are-depreciable-assets the line item of Insurance Expense. Whereas, in the company’s balance statement, the closing balance of the current prepaid insurance account will show a balance of $7,500 ($10,000- $2,500) for the quarter ending.