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In order to understand how prepaid insurance works, let’s take an example. Assume ABC company buys one-year insurance for its truck and pays $1200 for this insurance on December 1, 2022. In the company’s book, this prepaid insurance will be classified https://www.bookstime.com/articles/prepaid-insurance-journal-entry as an asset. In this case, it will be classified as a current asset on the Balance Sheet because it covers and falls within one year. The outward rent payment for each month will not be a cash transaction but only a record of accounts in the books.
Recall that prepaid expenses are considered an asset because they provide future economic benefits to the company. Also,Prepaid expenses are expenditures in one accounting period, and they you will not recogniz until a later accounting period. Hence, the value https://www.bookstime.com/ of prepaid expenses is expensed over time onto the balance sheet. So, the most common examples of prepaid expenses are prepaid rent and prepaid insurance. In the previous chapter, tentative financial statements were prepared directly from a trial balance.
What Are the Benefits of Prepaid Expenses?
The payment of expense in advance increases one asset (prepaid or unexpired expense) and decreases another asset (cash). BlackLine is a high-growth, SaaS business that is transforming and modernizing the way finance and accounting departments operate. Our cloud software automates critical finance and accounting processes. We empower companies of all sizes across all industries to improve the integrity of their financial reporting, achieve efficiencies and enhance real-time visibility into their operations. They are an advance payment for the business and therefore treated as an asset.
The value of the asset is then replaced with an actual expense recorded on the income statement. At the end of the year, there may be expenses whose benefits have been received but not paid for and expenses that may have been paid, but their benefit will appear in the next financial year. While the concepts discussed herein are intended to help business owners understand general accounting concepts, always speak with a CPA regarding your particular financial situation. The answer to certain tax and accounting issues is often highly dependent on the fact situation presented and your overall financial status. As the insurance coverage expires over multiple future periods, a series of subsequent entries such as the one above are made. They are classified as Assets in a company balance sheet since they relate to expenditures which have some future economic benefit to the company.
Prepaid insurance explained
The prepaid expenses are recognized because the expenses are booked in the books of accounts when they become due regardless of actual cash payment (matching principle). So prepaid expense account is created to record the payment of expenses in that accounting period in which it is paid but not yet become due. Prepaid expenses are future expenses that are paid in advance, such as rent or insurance.