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, prepaid insurance journal entry financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets.
Prepaid or unexpired expenses can be recorded under two methods — asset method and expense method. Almost any expense paid in advance can be considered a prepaid expense. Because you split the insurance expense evenly for the year, you will need to record the expense each month, meaning the above journal entry will need to be recorded each month for the next twelve months. As the prepaid insurance expires throughout the passage of time, the company needs to transfer the prepaid insurance that has expired in the period to the insurance expense. In the business, the company usually needs to make an advance payment for the insurance that it has purchases.
Prepaid Expenses FAQs
At the end of the year, there may be expenses whose benefits have been received but not paid for and expenses that may have been paid, but their benefit will appear in the next financial year. For example, because of recent legal issues, Jill puts her attorney on retainer. Though she pays the retainer in full, Jill still needs to determine how much she will need to expense each month as the retainer is used.
Prepaid insurance also helps businesses to maintain their financial stability over time by allowing them to budget for future expenses. This makes it easier for the insured to pay their premiums without facing a large, unexpected bill. The prepaid insurance payment is an important part of the insurance process. It helps to ensure that the insurance provider will continue to receive payments on time and that the insured will be able to pay for their policy without facing an exorbitant bill. Bill’s prepaid accounts in his seven-month policy will have been expensed by the end of the policy, and Bill will then be eligible to renew the policy.
Impact of prepaid expenses on liquidity ratios
The above journal uses the Other Income account to show it is not part of the normal day to day activity income earned by the business. Accountingcoach.com has a good example of accounting for payroll withholdings for health insurance. A business that owns motor vehicles will require insurance cover on those. Some insurance payments can go on to the Profit and Loss Report and some must go on the Balance Sheet. 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.
- Additionally, an organization reporting under US GAAP must follow the matching principle by recognizing expenses in the period in which they are incurred.
- Prepaid Insurance journal entry is passed to record the amount paid as advance for the insurance.
- Though she pays the retainer in full, Jill still needs to determine how much she will need to expense each month as the retainer is used.
- As each month passes, adjust the accounts by the amount of rent you use.
- The result of method 2 is an insurance expense of $2,500 and a prepaid expense of $7,500, which is the exact result of method 1.
