This adjusting entry is necessary for the company to not overstate its total assets as well as to not understate its total expenses during the period. Consequently, at the end of the month of January, when the company wants to record the insurance expense for the month, they will need to divide the amount paid ie. $24,000 by 12 months which will give the insurance expense for each month that is $2,000. I have entered their figures into the free bookkeeping software called Manager so you can see the insurance journal entry in action. Capital is the account used for showing how much personal money is used by the business owner to pay for business expenses. It can either be deposited into the business bank account and coded to Capital or presented by a journal like the one above.
Bill would then expense this prepaid insurance at the end of each month by deducting the insurance expense from his bank account and crediting it with ₹100. Although being a simple concept, it is important for an organization to correctly account for and recognize prepaid expenses on its balance sheet. Prepaid assets typically fall in the current asset bucket and therefore impact key financial ratios. Additionally, an organization reporting under US GAAP must follow the matching principle by recognizing expenses in the period in which they are incurred.
Motor Vehicle Insurance
Prepaid expenses are generally considered a current asset on the balance sheet unless they are not incurred for more than 12 months, and this is very rare. Bill would thus record a ₹700 prepaid expense when he pays his seven-month premium. He would debit the prepaid account and credit the cash account with ₹700.
As a rule of thumb, prepaid expenses have been paid but are yet to be realized whereas accrued expenses are incurred but yet to be paid. To conclude what has been explained above, prepaid insurance is a part of the current assets of the business because it has been paid off by the business already for future use. However, since now interest expense is a part of the income statement, the journal entry will now affect the current asset section of the balance sheet, as well as the expense section of the income statement.
Simplifying Prepaid Expenses Adjustment Entry with an Example
This requires proper calculation and amortization of prepaid expenditures such as insurance, software subscriptions, and leases. Sticking with the accrual method of accounting, a second important consideration when recording a prepaid asset is the utilization period. If the entirety of the prepaid asset prepaid insurance journal entry is to be consumed within 12 months, then it is deemed a current asset. However, it is not uncommon to see contracts spanning multiple years, being paid in advance. In these scenarios the portion of the prepaid obligation which exceeds 12 months is recognized as a long-term or noncurrent asset.