What kind of asset is prepaid insurance

With amortization, the amount of a common accrual, such as prepaid rent, is gradually reduced to zero, following what is known as an amortization schedule. The expense is then transferred to the profit and loss statement for the period during which the company uses up the accrual. Insurance is an excellent example of a prepaid expense, as it is customarily paid for in advance. When there is a payment that represents a prepayment of an expense, a prepaid account, such as Prepaid Insurance, is debited and the cash account is credited.

An amortization schedule that corresponds to the actual incurring of the prepaid expenses or the consumption schedule for the prepaid asset is also established. At the end of each accounting period, a journal entry is posted for the expense incurred over that period, according to the schedule. This journal entry credits the prepaid asset account on the balance sheet, such as Prepaid Insurance, and debits an expense account on the income statement, such as Insurance Expense.

Doing so records the incurring of the expense for the period and reduces the prepaid asset by the corresponding amount. The BlackLine Account Reconciliations product , a full account reconciliation solution , has a prepaid amortization template to automate the process of accounting for prepaid expenses.

It stores a schedule of payments for amortizable items and establishes a monthly schedule of the expenses that should be entered over the life of the prepaid items. The product then automatically amortizes the expense over future periods, eliminating the need to manage spreadsheets or other manual tracking systems. The template also contains an auto-populated roll forward schedule. It provides an automated solution for the creation, review, approval, and posting of journal entries.

This streamlines the remaining steps in the process of accounting for prepaid items. Prepaid insurance is commonly recorded, because insurance providers prefer to bill insurance in advance. If a business were to pay late, it would be at risk of having its insurance coverage terminated. In particular, the providers of medical insurance usually insist upon being paid in advance, so that a company must record an insurance payment at the end of one month as prepaid insurance, and then charge it to expense in the next month, which is the month to which the payment relates.

Prepaid insurance is nearly always classified as a current asset on the balance sheet , since the term of the related insurance contract that has been prepaid is usually for a period of one year or less. If the prepayment covers a longer period, then classify the portion of the prepaid insurance that will not be charged to expense within one year as a long-term asset.

Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract. September 23, Karon Warren. Article Highlights. What is prepaid insurance? How does prepaid insurance work? Prepaid expenses Prepaid insurance coverage is considered to be a prepaid expense by accountants. Types of prepaid insurance Some types of insurance, such as auto and health insurance, almost always operate on a prepaid basis, where the insured pays the premium up front for the coming term of coverage.

Balance sheet entries Insurance companies list prepaid insurance policies as assets on their balance sheet until they are completely used up and the term of coverage has expired. Benefits of prepaid insurance Once the initial payment has been made, the insured can enjoy the protection provided by the insurance policy until the end of the term. Prepaid insurance example When an auto insurer receives a payment for six months of auto insurance coverage, it is initially recorded as an asset.

Prepaid insurance frequently asked questions Do I get a discount for prepaying for more than a month in advance? Is prepaid insurance a current asset? Is prepaid insurance a debit or credit? The takeaway Prepaid insurance is common with some types of insurers, such as for auto and health. This credit is reduced by a certain amount each month until it expires. Credits that remain for more than a year are counted as long-term assets.

That's because most prepaid assets are consumed within a few months of being recorded. 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. Insurance coverage, though, is often consumed over several periods. In this case, the company's balance sheet may show corresponding charges recorded as expenses. Unless an insurance claim is filed, prepaid insurance is usually renewable by the policyholder shortly before the expiry date on the same terms and conditions as the original insurance contract.

However, the premiums may be marginally higher to account for inflation and other operating factors. Prepaid insurance is usually considered a current asset , as it becomes converted to cash or used within a fairly short time. But if a prepaid expense is not consumed within the year after payment, it becomes a long-term asset , which is not a very common occurrence.

The payment of the insurance expense is similar to money in the bank—as that money is used up, it is withdrawn from the account in each month or accounting period. But that changes once coverage begins. Corporate Finance. Health Insurance. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.

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