If the prepayment covers a longer period, then classify the portion of the prepaid insurance that will not be charged to expense within one year as a long-term asset. Prepaid insurance for businesses is very valuable in terms of providing financial stability, budgeting accuracy, and risk mitigation. However, to ensure accuracy of financial statements, it is essential that these are recorded in the correct accounting period.
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The ending balance in Depreciation Expense – Equipment will be closed at the end of the current accounting period and this account will begin the next accounting year with a balance of $0. The $1,500 balance in the asset account Prepaid Insurance is the preliminary balance. The correct amount is the amount that has been paid by the company for insurance coverage that will expire after the balance sheet date. If a review of the payments for insurance shows that $600 of the insurance payments is for insurance that will expire after the balance sheet date, then the balance in Prepaid Insurance should be $600. Let’s assume that a review of the accounts receivables indicates that approximately $600 of the receivables will not be collectible.
How to Record a Contra Account
- Since adjusting entries involve a balance sheet account and an income statement account, it is wise to monitor the balances in both Prepaid Insurance and Insurance Expense throughout the year.
- Follow these steps to ensure you’re recording the cost of prepaid insurance correctly in your accounting records.
- Prepaid expenses represent expenditures that have not yet been recorded by a company as an expense, but have been paid for in advance.
- Contra accounts are used to reduce the original account directly, keeping financial accounting records clean.
- The 500 year-old accounting system where every transaction is recorded into at least two accounts.
- It adds the used amount to the expense account and reduces the prepaid expense account to reflect the lower asset value.
Upon signing the one-year lease agreement for the warehouse, the company also purchases insurance for the warehouse. The company pays $24,000 in cash upfront for a 12-month insurance policy contra expense account for the warehouse. As prepaid insurance is an asset that will expire through the passage of time, the cost of expiration will need to be recognized as an expense during the period.
- Prepaid insurance is of great importance to any business, as it ensures that there is no loss in insurance coverage due to missed payments.
- It is also important not to confuse a prepaid expense with an accrued expense.
- Unlike conventional expenses, businesses tend to receive something of value from the prepaid expense over the course of several accounting periods.
- The $25,000 balance in Equipment is accurate, so no entry is needed in this account.
- If a business were to pay late, it would be at risk of having its insurance coverage terminated.
- Among these, one particularly important type of prepaid expense is prepaid insurance.
Can prepaid insurance have a credit balance?
At the same time, the company records a rental expense of $3,000 on the income statement. For example, if a company has $24,000 to cover employee insurance, it pays for the policy upfront and then makes an adjusting entry each month to account for the insurance costs as they’re incurred. A debit will be made to the bad debt expense for $4,000 to balance the journal entry. Although the accounts receivable is not due in September, the company still has to report credit losses of $4,000 as bad debts expense in its income statement for the month.
The matching principle is the basis for allocating expenses to the periods in which they are used or consumed. It requires that expenses be matched with the revenues they help generate. However, the rights to these future benefits or services rarely last more than two or three years. Some insurers prefer that insured parties pay on a prepaid schedule such as auto or medical insurance. Get granular visibility into your accounting process to take full control all the way from transaction recording to financial reporting. Derek has over 10 years of experience writing web content for a variety of online publications.
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For example, assume Company ABC purchases insurance for the upcoming 12-month period. Company ABC will initially book the full $120,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash. 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.
Then, when the expense is incurred, the prepaid expense account is reduced by the amount of the expense, and the expense is recognized on the company’s income statement in the period when it was incurred. Prepaid expenses are payments for goods or services that will be received in the future. These expenses are not initially recorded on a company’s income statement for the period when the money changes hands. Unexpired or prepaid expenses are the expenses for which payments have been made, but full benefits or services have yet to be received during that period. If an insurance company issues a premium refund to a business for whatever reason, this refund will reflect as a credit in the prepaid insurance account and a debit in the cash account. To adjust this, the accountant will need to debit the refund amount to the prepaid insurance account by crediting the insurance expense.
Contra asset account definition
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