What is a Prepaid Expense? Definition & Process

You’ll take several steps to record your prepaid expenses properly. This starts with determining if the amount should be expensed over multiple accounting periods, how much should be expensed each period, and for how long.

The accounting treatment for prepaid insurance must consider two aspects of the account. The journal entry for this transaction usually occurs as follows. Prepaid expenses refers to payments made in advance and part of the amount will become an expense in a future accounting period. A common example is paying a 6-month insurance premium in December that provides coverage from December 1 through May 31. On July 1, the company receives a premium refund of $120 from the insurance company.

Accounting for Prepaid Rent

Insurance is generally prepaid as companies may purchase it on a six-month, one-year or multiyear term. The total amount of prepaid insurance is not recorded as an immediate expense at the time of the purchase when the insurance has not been used. Thus, the total amount of cash spent on the insurance premium is not an expense in the current period. Companies simply have exchanged cash for the right to certain insurance coverage in the future. Accounting for unearned revenue can also follow a balance sheet or income statement approach.

For the most accurate information, please ask your customer service representative. Clarify all fees and contract details before signing a contract or finalizing your purchase. Each individual’s https://quickbooks-payroll.org/ unique needs should be considered when deciding on chosen products. After opening its retail location, Johnny’s Mattress Emporium also needs commercial renters insurance to protect its assets.

Intelligent Rebate Management Solution

To help keep track of your prepaid expenses, consider using an automation solution so that nothing slips through the cracks. This way, you can ensure that your financial statements and reports are always complete. Depending prepaid insurance journal entry on your line of business, you may have some or several. Here, we will cover the definition of prepaid expenses, how to properly record them, and how automated financial software can manage the nuances for you.

Are there any benefits to filing taxes for a small business with no income? The Insurance Expense would now be shown in the income statement for January and Balance Sheet prepared for Jan 31st would show the Prepaid Insurance amount or $2,750. As the name implies, Prepaid Expenses represent a prepayment for a future expense. However, one simple approach is called the straight-line method, where an equal amount of asset cost is assigned to each year of service life. One might find it necessary to “back in” to the calculation of supplies used.

What are prepaid expenses?

For example, you move into a new building at the end of December, with your first month’s rent due Jan. 1. Because your new landlord allowed you to move in early, he’s now requesting you pay rent for the entire year, in advance. BlackLine partners with top global Business Process Outsourcers and equips them with solutions to better serve their clients and achieve market-leading automation, efficiencies, and risk control. By outsourcing, businesses can achieve stronger compliance, gain a deeper level of industry knowledge, and grow without unnecessary costs.

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. Therefore, it should be recorded as a prepaid expense and allocated out to expense over the full twelve months. Due to the nature of certain goods and services, prepaid expenses will always exist. For example, insurance will always be a prepaid expense as it provides financial protection in the event of any unfortunate incident in the future. No insurance company would sell insurance that covers all the expenses after the unfortunate incident, so expenses must be prepaid. Companies use two sets of journal entries to record the insurance-related transactions, involving both prepaid insurance and expired insurance. When companies initially pay for the total insurance premium, a debit is entered to the asset account of prepaid insurance and a credit entered to the cash account for the cash spent.