Inventories and prepaid expenses are not quick assets because they can be difficult to convert to cash, and deep discounts are sometimes needed to do so. Assets categorized as “quick assets” are not labeled as such on the balance sheet; they appear among the other current assets. The adjusting journal entry is done each month, and at the end of the year, when the insurance policy has no future economic benefits, the prepaid insurance balance would be 0. The policies are intended to cover not only its property and products but also to protect its workers. Unexpired premiums should be listed as prepaid insurance, which is listed in an asset account. Prepaid expenses are those you must pay in advance of their use.

Prepaid insurance requires you to pay your premium before receiving the financial benefits of the policy. Insurers commonly offer prepayment for many types of insurance, including auto and homeowners insurance. Continue reading to see examples of prepaid insurance and how it’s reflected on financial statements. Company XYZ has paid an insurance expense of $500 for the next quarter.

Definition of Prepaid Insurance as a Short-term Asset

It reflects the strong earning power of the company and creates goodwill in the market. Companies that take care of assets and employees by paying reasonable advance insurance premiums are considered strong financial companies. There should always be a check regarding the period for advance in insurance. A company shouldn’t advance too much as it may reflect badly on the profitability. Prepaid insurance represents the amount of coverage that you have bought in advance.

Prepaid insurance is considered a business asset, and is listed as an asset account on the left side of the balance sheet. The payment of the insurance expense is similar to money in the bank, and the money will be withdrawn from the account as the insurance is « used up » each month or each accounting return on equity – roe definition period. When the full amount is received by the insurer, accounting will treat the payment as an asset. An entry will then be created on the books to move this amount from current assets to the expense side. The leftover ($16,000 in this case) will be counted as prepaid insurance for the insurer.

Is prepaid insurance an asset?

In other words, you are paying upfront for a benefit that will be used later. Depending on the policy, a business may pay their insurance premiums on a monthly, quarterly, or annual basis. When the business pays for the premiums upfront, they are paying in advance for the entire policy period. Therefore, the entire prepaid insurance expense is recorded on the “asset” side of the balance sheet. Two journal entries are necessary to record and report prepaid asset transactions.

The insurance company’s balance statement shows these payments as a current asset if the customers don’t use them and remain valid. Prepaid insurance is the portion of an insurance premium that has been paid in advance and has not expired as of the date of a company’s balance sheet. This unexpired cost is reported in the current asset account Prepaid Insurance.

Is prepaid insurance a debit or credit?

Prepaid insurance refers to paying your insurance premiums in advance in a lump sum, usually for a six- or 12-month policy. Insurance providers often provide premium discounts to incentivize policyholders to make lump-sum payments on their insurance policy. This also helps insurance companies with customer retention, since customers may be less likely to switch carriers mid-policy if they’ve already paid upfront.

The terms of insurance coverage are usually the same upon renewal unless otherwise stated by the insurance company and have to be agreed on by the client before a new contract ensures. Prepaid insurance is commonly recorded, because insurance providers prefer to bill insurance in advance. If a business were to pay late, it would be at risk of having its insurance coverage terminated. It’s common to classify prepaid insurance as a current asset because you can convert it to cash or use it within short periods.

Why Companies Count Prepaid Insurance

For example, every company must pay an insurance fee to protect its assets, employees, etc. When the insurance premium is paid in advance, that is called prepaid insurance. A prepaid expense is an expense that has been paid for in advance but not yet incurred. In business, a prepaid expense is recorded as an asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. 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.

• The term « prepaid » means the part of the insurance premium that has not been used up as on the date of the balance sheet.
• If the prepaid insurance is not fully used when financial statements are prepared, it is going to be an asset at the payment date.
• But if a prepaid expense is not consumed within the year after payment, it becomes a long-term asset, which is not a very common occurrence.
• However, it not until month six that the company has used all of the $24,000 worth of insurance.

However, the rights to these future benefits or services rarely last more than two or three years. Prepaid insurance has already become an inescapable expense for most American individuals and corporate entities but what does it even mean? When canceling an insurance policy, you may incur a cancellation fee. Derek has over 10 years of experience writing web content for a variety of online publications. His pieces range from finances and entertainment to religion and philosophy. For the past three years, Derek has focused on writing financial literacy articles for credit unions throughout the country.