Accounting reports certain business transactions as assets, which represent value to a business. Tangible assets are items an individual can see or touch, such as buildings and equipment. Intangible assets — such as patents and copyrights — don't have a physical presence. Prepaid insurance isn't an intangible asset; it falls under a company’s prepaid asset classification.
A prepaid asset is an item for which a company pays but doesn't receive the full benefit from the item. Prepaid insurance is among the most common prepaid assets. A company may pay the full premiums when purchasing an insurance policy. The policy has value for 12 months, however, providing value to the company over this time period. Hence, a company records prepaid insurance as an asset.
Journal Entry Examples
Two journal entries are necessary to record and report prepaid asset transactions. When purchasing the policy, accountants debit prepaid insurance -- asset account -- and credit cash or accounts payable. Each month after the initial purchase, accountants debit insurance expense and credit prepaid insurance. These entries continue until the policy expires.
Balance Sheet Reporting
Prepaid assets fall under the current asset section of a company’s balance sheet. A company expects to use all current assets within 12 months. Prepaid assets can also be highly liquid, meaning the company can easily turn these items into cash if needed. For prepaid insurance, this typically involves canceling the policy and receiving a refund on the used policy portion.
Companies should list all prepaid assets separately. A corresponding expense account is also necessary. This allows for accurate reporting for each different transaction type that occurs during normal operations. Multiple prepaid insurance policies can all reside in the same account, however, as they all represent the same type of transaction, like insurance purchases and expenditures.
- "Intermediate Accounting"; David Spiceland, et al.; 2007