Insurance is a very important element of modern-day finance and according to many experts, it is an inescapable expense. Some common types of insurances are car insurance, home insurance, life insurance, and health insurance, etc. and currently, all these insurances are very important for most Americans. In insurance “Prepaid insurance” is a very common term but many people don’t have a clear idea about it and wonder whether prepaid insurance is an asset or not. If you are wondering about the same question then read the article thoroughly.
Yes, prepaid insurance is an asset and usually, it is a short-term or current asset. This is because in prepaid insurance, the prepaid amount will be used up or it will become expire within one year of the balance sheet date. For prepaid insurance, the payment of the insurance expense is similar to money in the bank. So, basically, it likes withdrawing money from the account in each month or accounting period.
What Is Prepaid Insurance?
The term prepaid means paying for some products or services in advance. For insurance, “prepaid” also works similarly. Here, individuals pay the insurance premiums in advance. So prepaid insurance refers to payments that are made in advance for insurance services or coverage by the insurance bearer. Usually, for prepaid insurance, the premiums are paid a full year in advance, and on some occasions, the coverage might cover more than 12 months. Prepaid insurance is common for health, life, hazard, automotive, liability, and other forms of coverage required by a business. When a business or individual pays the premium in advance the total amount is shown as a current asset on an insurance company’s balance sheet and it is carried as an asset until the coverage is used. So, prepaid insurance is simple insurance that is paid for in advance.
How Does Prepaid Insurance Work?
Now that we have some clear idea about prepaid insurance, let’s dig into more details and know-how prepaid insurance works. When a business or individual decides to pay for insurance in advance, then the premium amount is considered as a prepaid expense by accountants. It means the payment is made before the insurance coverage or service has been used. So, when someone purchases prepaid insurance, it covers a period of time in the future and the premiums or payment is recorded in one accounting period. However, the contract isn’t in effect until a future period. For the insurance company, the advance payment is carried on as a current asset on the balance sheet until the coverage is consumed.
So, when the insurance bearer uses the insurance coverage, the used amount is moved from an asset and re-entry to the expense side of the company’s balance sheet. In many situations, insurance coverage is consumed over several periods. If this happens then the company’s balance sheet will show corresponding charges recorded as expenses. However, the prepaid insurance is usually renewable by the policyholder before the expiry date and the terms and conditions remain the same as the original contract. But for renewed insurance, the premium might be high because of inflation and other operating factors.
Example Of Prepaid Insurance
To illustrate more about how prepaid insurance works let’s assume that a business/company makes an auto insurance payment for six months and the insurance premium is $3,000. So, the payment will be recorded as a debit of $3,000 to prepaid insurance and a credit of $3,000 to cash. If the full insurance is expired then the entire $3,000 will be reported as prepaid insurance. However, it will change when the coverage begins. If the insurer uses $500 of the coverage, then the adjusting entry will show a debit insurance expense for $500 and credit prepaid insurance for $500. So, it means the debit balance in prepaid insurance will be $3,000.
Reasons Prepaid Insurance A Short-Term Asset
The basic definition of a short-term or current asset is cash. Moreover, assets that might turn to cash within one year is also considered short-term asset. If a company’s operation time is more than one year then the definition will allow the assets to turn into cash and they will be regarded as a current asset. So, when you make an advance payment for insurance premiums and if it covers a one-year period or less then the amount will be considered as a current asset. On the other hand, if the company would have to pay an insurance premium in advance for at least one year then the portion of the prepayments won’t consider as a short-term asset. It will be considered a long-term asset.
What Are The Accounting Steps To Record Prepaid Insurance?
There are some specific accounting steps available to record prepaid insurance. They are –
1. You have to change the invoice from the insurance company to the prepaid expenses account
2. Entry the expense in the reconciliation worksheet that is used for prepaid expenses
3. Determine the number of periods over which the prepaid amount will be repaid
4. Specify the amount of repayment that will be charged in each period
5. In each period, you should enter the amount as an insurance expense on the income statement
6. After full repayment, match the worksheet total to the prepaid expense account balance
FAQs About Is Prepaid Insurance An Asset
Do I Get A Discount For Prepaying For More Than A Month In Advance?
The answer to this question depends on various factors as well as the insurance company. However, in most cases, you will get a discount for prepaying for more than a month in advance. There are many insurance companies available that offer discounts for paying insurance premiums in larger amounts, for example semiannually or annually. Moreover, you might be able to reduce the billing fees by paying the premiums in advance.
Is Prepaid Insurance A Current Asset?
Yes, prepaid insurance is a current asset because the insurance premium is converted to cash or it will be used within a short period of time.
Is Prepaid Insurance An Asset On The Trial Balance?
Yes, prepaid insurance is an asset on the trial balance. This type of asset is recorded as a current asset and they are shown on the company’s balance sheet.
What Is The Journal Entry Of Prepaid Insurance?
In the journal entry, when the prepaid insurance is charged to expense it goes as the debit to the insurance expense account and credits the prepaid insurance account.
Is Accounts Payable An Asset?
No, accounts payable is not an asset. It is considered a current liability.
Last Updated on February 9, 2022 by
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.