Prepaid Expenses Examples, Accounting for a Prepaid Expense

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. The journal entry is debiting insurance expenses and credit prepaid insurance. They are an advance payment for the business and therefore treated as an asset. The accounting rule applied is to debit the increase in assets” and “credit the decrease in expense” (modern rules of accounting).

how to make journal entry for prepaid insurance

I have entered their figures into the free bookkeeping software called Manager so you can see the insurance journal entry in action. The recommendation is to group this insurance with the other motor vehicle expenses (fuel, r&m) in the bookkeeping accounting records. The first step in recording a prepaid expense is the actual purchase of the expense. For example, if you pay your insurance for the upcoming year, you would first pay the expense, making sure to record it properly. They are expenses paid in advance for benefits yet to be received. For example, on December 18, 2020, the company ABC make an advance payment of $6,000 for the fire insurance that it purchase to cover the whole year of 2021.

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Rather, they provide value over time; generally over multiple accounting periods. The reason is that the expense expires as you use it, thus, you can’t expense the entire value of the prepaid service immediately. You can only expense a portion of the expense that has been used. prepaid insurance journal entry So when making a journal entry for prepaid insurance, you record the prepaid expense in your business financial records and adjust entries as you use up the service. At most companies, insurance is considered an operational expense and recorded on the income statement.

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  • According to the three types of accounts in accounting “prepaid expense” is a personal account.
  • For example, if you pay your insurance for the upcoming year, you would first pay the expense, making sure to record it properly.
  • The process of recording prepaid expenses only takes place in accrual accounting.

The journal entry above shows how the first expense for January is recorded. The account in question is debited to record the related journal entry. Assets and expenses are increased by debits and decreased by credits. Before diving into the wonderful world of journal entries, you need to understand how each main account is affected by debits and credits. Again, anything that you pay for before using is considered a prepaid expense. 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.

What is considered a prepaid expense?

Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurer. The company sells the policy to the customer and may offer other types of coverage. The spreadsheet would continue through December, displaying the amount that will need to be expensed each month. This can be helpful for creating your monthly adjusting entries.

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