Prepaid Expenses Examples, Accounting for a Prepaid Expense

2022年2月3日

Rarely, an insurance policy will extend coverage beyond the 12-month accounting period following payment of the initial premium. In such a case, the portion of insurance prepaid in the prior year and used in the following year is a long-term asset. From the perspective of a business, the initial transaction of cash to a prepaid account is a debit expense between two current accounts. As these accounts are both asset accounts, they do not increase or decrease any value on the balance sheet. The reason prepaid expenses exist is because of the rules of accounting.

Ensure services revenue has been accurately recorded and related payments are reflected properly on the balance sheet. Accounting records that do not include adjusting entries to show the expiration or consumption of prepaid expenses overstate assets and net income and understate expenses. Also, an already used portion of the prepaid expense increases the expense amount entry and decreases the total prepaid asset value.

Prepaid Insurance

Most prepaid expenses appear on the balance sheet as a current asset unless the expense is not to be incurred until after 12 months, which is rare. Insurance providers prefer to bill insurance in advance and so knowing the right journal entry for prepaid insurance is very important. For instance, the providers of medical insurance usually insist on advance payment, and prepaid insurance journal entry if a business were to pay late, it would be at risk of having its insurance coverage terminated. Prepaid insurance is reported on the balance sheet as a current asset because the term of the related insurance contract that has been prepaid is usually for a period of one year or less. A business buys one year of general liability insurance in advance, for $12,000.

For example, office supplies are considered an asset until they are used in the course of doing business, at which time they become an expense. At the end of each accounting period, adjusting entries are necessary to recognize the portion of prepaid expenses that have become actual expenses through use or the passage of time. Prepaid expenses come in different forms, and it is crucial to identify them to record them accurately. The two types of prepaid expenses are deferred expenses and prepaid income.

Impact of prepaid expenses on liquidity ratios

As the goods or services are utilized over time, the prepaid expense asset account is gradually reduced, and the corresponding expense account is increased. For example, when a business pre-pays for rent, it initially records the payment as a prepaid rent asset. https://www.bookstime.com/articles/what-is-encumbrance-accounting As each month passes and the business utilizes the rented property, it recognizes the portion of prepaid rent that has been consumed as an expense in the income statement. Now that you know what prepaid expenses journal entry is let’s know the account types.

When an advance insurance payment is made, the prepaid insurance journal entry is a debit to the prepaid insurance account and a credit to the cash account. According to the accounting debit and credit rules, a debit entry increases assets, expenses, and dividends accounts while a credit entry decreases them. Prepaid insurance is an asset and going by the debit and credit rules, the prepaid insurance account increases by a debit entry while the cash account decreases by a credit entry. Each journal entry requires a debit to Insurance Expense and a credit to Prepaid Expenses.