Prepaid Insurance is the amount of money that you’ve paid out for your insurance premiums that you haven’t yet used. With many business insurance policies, you have to pay a significant amount of the premium up front or in larger installments. You don’t have the opportunity to pay an equal monthly amount. When this happens, you want to make sure that your expense is recognized properly throughout the policy period.

 

Here are The Steps to Handle Prepaid Insurance:

 

If you have an insurance policy that requires a full payment on January 1^st every year, for the policy period from January 1^st through December 31^st, you need to spread the cost over the full 12 months of the year.

 

First, you need to divide the full policy payment by 12 to calculate the monthly expense amount.

 

When you record the full payment to your insurance provider, you should post this to your Prepaid Insurance account on your balance sheet.

 

Then, at the end of each month, you need to record a journal entry to expense the monthly amount (1/12^th) of the premium. You will increase your insurance expense (debit) and decrease the amount in your prepaid insurance account (credit).

 

Even if your policy renews mid-year, you would follow the same process. You’ll just have an adjustment to the monthly expense at whatever month your policy renews. At the end of each policy, your prepaid insurance account should zero out (unless you’ve made a payment on the new policy).

 

If you have to pay a large payment up front and then monthly, you should still make sure you’re recording the monthly expense based on the full policy premium divided by 12 months. Every payment you make should be recorded to your prepaid insurance account and every month you should post an expense entry.

 

If you do not handle prepaid insurance correctly, you can skew your financials, having a large expense in one month, while having no expense in other months. This can make it difficult to review your profitability and understand your company’s true performance.

More definitions and examples here.

Written by: Shauna Huntington