When you're running a business, it's important to have a clear understanding of your company's balance sheet. Prepaid insurance, for example, will be listed under Assets. It represents the insurance premiums that have been paid in advance. Since the cost of coverage is spread over several years, it may create confusion. For this reason, many accountants use worksheets to keep track of these numbers and prevent any errors on the prepaid expenses balance sheet.
What Is Prepaid Insurance?
Some companies choose to pay insurance premiums in advance, such as for the next year. Business owners often choose this option because it allows them to realize savings. The same goes for most prepaid expenses, such as rent. For example, if you pay rent for your office in advance, you may receive a discount or qualify for additional business deductions.
Where insurance is prepaid, the amount is usually recorded on the company's balance sheet. In this case, your accountant will create a prepaid rent journal entry that includes:
- Prepaid rent account (as debit)
- Cash (as credit)
Initially, the prepaid rent or insurance will be recorded as an asset. As it expires, it will be recorded as an expense.
How Prepayment Accounting Works
Prepaid insurance is recorded as a current asset since it will not be consumed until a future period. If you have paid for several years in advance, it's considered a long-term asset. As the coverage is "consumed" each month or each accounting period, it will be gradually moved to the prepaid expenses journal entry. Basically, it will no longer be considered an asset, but an expense.
Most accountants prefer not to record small expenditures on the prepaid expenses balance sheet since they are difficult to track over time. Instead, they charge remaining balances once they reach a certain minimum level or at the end of each accounting period.
Recording on a Balance Sheet
Since prepaid expenses are not yet incurred, they are recorded as assets. Your accountant will create an adjusting entry for these expenditures to move them from the Assets section to Expenses. Prepaid insurance and prepaid rent, for instance, fall under this category.
You can also pay for electricity or office supplies in advance and record them as assets. As you use these services, you must transfer them to the prepaid expenses balance sheet. Your company's financial statements will not be affected by the initial journal entry for prepaid expenses.
Example of Prepaid Insurance
Wilson's Widgets employs 10 people. Their insurance company gives them a discount for prepaying their premiums. Pay early and the cost is $1,000/year. This saves them $300 per employee annually, so Wilson pays the $10,000 bill each fiscal year. At the beginning of the year, Wilson records $10,000 as a current asset. Each month, he moves $834, or 1/12 of the total, into the prepaid expenses journal entry and removes the same amount from the current asset column.