Prepaid Expenses Journal Entry Definition, How to Create, & Examples

All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. For example, because of recent legal issues, Jill puts her attorney on retainer. Though she pays the retainer in full, Jill still needs to determine how much she will need to expense each month as the retainer is used.

As the good or service is delivered, the asset’s value is decreased, and the amount is expensed to the income statement. Assume a company ABC purchases insurance for the upcoming 12-month period and pays $180,000 upfront for it. ABC Company will initially book the full $180,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash. Each month, an adjusting entry will be made to expense $15,000 (1/12 of the prepaid amount) to the income statement through a credit to prepaid insurance and a debit to insurance expense. In the 12th month, the final $15,000 will be fully expensed and the prepaid account will be zero.

Is Prepaid Insurance an Asset?

In some instances, a prepaid expense is not applied equally because the benefit is not the same for each accounting period. For example, an insurance policy may offer a different level of coverage at the beginning of the term than it does at the end. In this instance, the amortization would reflect a different cost for the corresponding reporting periods. For example, if a business pays for a legal retainer for one year of service, the value of that retainer will be amortized over twelve months. The calculated equivalent of a monthly retainer will be recorded as an expense in each of the twelve monthly accounting periods within the year. This will allow the business to apply or match the expense of the legal retainer evenly to each reporting period that is receiving the benefit of the legal services.

Step Aside Corporation paid $1,200 cash for 12 months of an insurance policy that begins next month. Prepaid expenses usually provide value to a company over an extended period of time, such as insurance or prepaid rent.

Are Prepaid Expenses Debits or Credits?

Accounting for unearned revenue can also follow a balance sheet or income statement approach. The balance sheet approach for unearned revenue is presented at left below. At right is the income statement approach, wherein the initial receipt is recorded entirely to a Revenue account. Subsequent end-of-period adjusting entries reduce Revenue by the amount not yet earned and increase Unearned Revenue. Again, both approaches produce the same financial statement results.

The initial journal entry for a prepaid expense does not affect a company’s financial statements. prepaid insurance journal entry The initial journal entry for prepaid rent is a debit to prepaid rent and a credit to cash.

Why Do Businesses Amortize Prepaid Expenses?

This can be helpful for creating your monthly adjusting entries. The journal entry above shows how the first expense for January is recorded. Prepaid expenses are classified as assets as they represent goods and services that will be consumed, typically within a year. While the concepts discussed herein are intended to help business owners understand general https://www.bookstime.com/ accounting concepts, always speak with a CPA regarding your particular financial situation. The answer to certain tax and accounting issues is often highly dependent on the fact situation presented and your overall financial status. As the insurance coverage expires over multiple future periods, a series of subsequent entries such as the one above are made.

• Due to its nature, people may wonder whether prepaid insurance is an asset or an expense.
• Accounts receivable represents money owed to a company for goods or services it has already delivered.
• 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.
• Thus, prepaid expenses aren’t recognized on the income statement when paid because they have yet to be incurred.
• Subsequent end-of-period adjusting entries reduce Revenue by the amount not yet earned and increase Unearned Revenue.
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Prepaid expenses journal entry

Thus, the amount charged to expense in an accounting period is only the amount of the prepaid insurance asset ratably assigned to that period. 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.