Prepaid Expenses: Definition, Examples & Recording Process


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Prepaid Expenses: Definition, Examples & Recording Process


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prepaid insurance journal entry

Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company. Prepaid expenses are like prepaid insurance which is a liability that can be recorded as either an asset or as an expense depending on the accounting policy adopted by the business. Due to its nature, people may wonder whether prepaid insurance is an asset or an expense. Essentially, it occurs due to the insurance premium paid by companies. However, due to the nature of this transaction, companies cannot classify it as such. The primary reason companies must classify this insurance as prepaid is that it relates to the unexpired portion.

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Businesses amortize prepaid expenses according to the matching principal. This states that revenue and related expenses must be recorded in the same accounting period when the transaction occurs, regardless of when money actually changes hands. Because of how certain goods and services are sold, most companies will have one or more prepaid expenses. For example, the purpose of insurance is to buy proactive protection for the future. No insurance company would sell insurance that covers a past event, so insurance expenses must be prepaid by businesses.

How Do Prepaid Expenses and Accounts Payable Affect Cash Flow?

The initial entry is a debit of $12,000 to the prepaid insurance account, and a credit of $12,000 to the cash account. In each successive month for the next twelve months, there should be a journal entry that debits the insurance expense account and credits the prepaid expenses account. Companies record this asset under current assets on the balance sheet. After that period, the insurance premium may expire, converting it to an expense. Therefore, it will no longer stay as prepaid insurance on the balance sheet. However, they don’t need to worry about the accounting implications. Prepaid expenses are payments made for goods or services that will be received in the future.

What is a prepaid account in accounting?

A prepaid expense is a type of asset on the balance sheet that results from a business making advanced payments for goods or services to be received in the future. Prepaid expenses are initially recorded as assets, but their value is expensed over time onto the income statement.

Additional expenses that a company might prepay for include interest and taxes. Interest paid in advance may arise as a company makes a payment ahead of https://www.bookstime.com/ the due date. Meanwhile, some companies pay taxes before they are due, such as an estimated tax payment based on what might come due in the future.

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As a business owner, you have many options for paying yourself, but each comes with tax implications. The right financial statement to use will always depend on the decision you’re facing and the type of information you need in order to make that decision. Self-employment comes with many benefits — and a high tax rate.

  • The business records a prepaid expense as an asset on the balance sheet because it signifies a future benefit due to the business.
  • Accrued revenue—an asset on the balance sheet—is revenue that has been earned but for which no cash has been received.
  • The amount of interest therefore depends on the amount of the borrowing (“principal”), the interest rate (“rate”), and the length of the borrowing period (“time”).
  • On the other hand, liabilities, equity, and revenue are increased by credits and decreased by debits.
  • Recording an advanced payment made for the lease as an expense in the first month would not adequately match expenses with revenues generated from its use.
  • Any portion of the amount used during the period becomes an expense for the company.

Insurance Expense, also called Insurance Premium, is the amount a Company pays to obtain an insurance contract for covering their risk from any unexpected catastrophe. Prepare a journal entry on July 9 for fees earned on the account, $12,000. Prepare a journal entry on July 9 for fees earned on account, $112,000.

Example – Journal Entry for Prepaid Insurance

DrPrepaid insuranceCrCash or bankAs time goes by, the prepaid insurance expires. During this period, companies must transfer the expired portion of the premium to the income statement. The journal entry for this aspect of prepaid insurance is as follows. The easiest way to manage prepaid expenses is by using accounting software, which will automatically post a journal entry each month to reduce the balance in your prepaid accounts. But even if you simply use a spreadsheet to calculate your monthly expenses, managing prepaid expenses is one of the easier things you’ll need to manage. Sometimes, your accounting software can handle the amortization expense creation process, so your monthly journal entries will be completed automatically.

How are prepaid expenses treated?

A prepaid expense is an expenditure paid for in one accounting period, but for which the underlying asset will not be consumed until a future period. When the asset is eventually consumed, it is charged to expense. If consumed over multiple periods, there may be a series of corresponding charges to expense.

Simplify, standardize, and automate your financial close in SAP. Paid 60,000 rent in the month of December prepaid insurance journal entry which belongs to the next year and doesn’t become due until January of the following year.


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