Is Prepaid Insurance an Asset or Liability?

Insurance provides protection for the business against loss due to theft, vandalism or lawsuits. Insurance policies extend for a specific period of time, either for several months or several years. The company pays the insurance premium at the time it purchases the policy. The amount paid applies to the provisions of the contract throughout the entire life of the policy.

Businesses purchase insurance policies for extended periods of time. The insurance policy specifies the term that the insurance company provides benefits for the business. When the business purchases the insurance policy, the accountant records a debit to Prepaid Insurance and a credit to Cash. Prepaid Insurance represents an asset to the business since it will reap the benefits of the insurance policy for future periods. The accountant includes Prepaid Insurance with current assets on the balance sheet.

Every month, a portion of the insurance benefit expires. The company enjoyed the security provided by the insurance coverage for that month. When the month ends, the company records the expiration of one month of insurance coverage. The accountant reduces the balance in Prepaid Insurance by the portion that expires. The accountant records a debit to Insurance Expense and a credit to Prepaid Insurance. Insurance Expense is an operating expense and reduces net income on the income statement.

On the other hand, insurance companies provide insurance coverage to the business customer. Providing insurance coverage serves as the company’s primary business operation. When the insurance company sells an insurance policy, it owes the customer insurance coverage for the duration of the policy. The accountant records a debit to Cash and a credit to Unearned Insurance Revenue. Unearned Insurance Revenue represents a liability to the insurance company and is reported with current liabilities on the balance sheet.

Every month, a portion of the insurance coverage owed to clients expires. When the month ends, the insurance company recognizes the revenue earned through the expiration of this coverage. The accountant debits Unearned Insurance Revenue and credits Insurance Revenue. Insurance Revenue is reported with sales on the income statement.