How to Record a Prepaid Expense

All 12 months from Jan’20 to Dec’20 will be charged in each period against the prepaid expense account to reduce the prepaid account to zero by end of the year. They are an advance payment for the business and therefore treated as an asset. The accounting rule applied is to debit the increase in assets” and “credit the decrease in expense” (modern rules of accounting). If we talk about prepaid expenses in a journal entry, prepaid expenses are services paid in advance of being received. Consider that the company’s only prepaid expense is its liability insurance policy premiums.

• This journal entry credits Prepaid Insurance’s prepaid account on your balance sheet and debits Insurance expenses on your income statement.
• Prepaid expenses are crucial for running a business and must be understood to manage cash flow.
• The advance payment of expenses does not provide value right away.
• 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.

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. Bill’s prepaid accounts in his seven-month policy will have been expensed by the end of the policy, and Bill will then be eligible to renew the policy. Let’s say that you prepay six months of rent, totalling ₹7,000.

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When an advance insurance payment is made, the prepaid insurance journal entry is a debit to the prepaid insurance account and a credit to the cash account. According to the accounting debit and credit rules, a debit entry increases assets, expenses, and dividends accounts while a credit entry decreases them. Prepaid insurance is an asset and going by the debit and credit rules, the prepaid insurance account increases by a debit entry while the cash account decreases by a credit entry. Insurance providers prefer to bill insurance in advance and so knowing the right journal entry for prepaid insurance is very important.

• Thus, the amount charged to expense in an accounting period is only the amount of the prepaid insurance asset ratably assigned to that period.
• You may be able to set up a recurring journal entry in your accounting software that will complete this automatically.
• First, debit the Prepaid Expense account to show an increase in assets.
• The initial journal entry for a prepaid expense does not affect a company’s financial statements.

Several purchases that you make in small businesses can be considered prepaid expenses. Now, that we understand this, what journal entries will one make to record the $100 worth of insurance used and the $1,100 worth of prepaid insurance remaining? To answer this, let’s discuss the journal entry for prepaid insurance. As each month passes, adjust the accounts by the amount of rent you use. Since the prepayment is for six months, divide the total cost by six ($9,000 / 6). In small business, there are a number of purchases you may make that are considered prepaid expenses.

Continue the process until the prepaid expense account is $0

The advance payment is recorded as prepaid insurance on the customers’ financial statements. The prepaid insurance is the current assets on the company balance sheet. The insurance expense prepaid insurance journal entry account increases by the debit entry while the prepaid insurance account decreases by the credit entry. This unexpired cost is reported in the current asset account, Prepaid Insurance.

• When the company makes an advance payment for insurance, it can make prepaid insurance journal entry by debiting prepaid insurance account and crediting cash account.
• 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.
• As each month passes, adjust the accounts by the amount of rent you use.
• Once the journal entry for prepaid expenses has been posted they are then arranged appropriately in the final accounts.
• The journal entry is debiting prepaid insurance and credit cash.
• It’s important to keep track of these payments, as they can have a significant impact on the company’s bottom line.

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Overview: What is a prepaid expense?

Repeat the process each month until the policy is used and the asset account is empty. Each month, adjust the accounts by the amount of the policy you use. Since the policy lasts one year, divide the total cost of $1,800 by 12. When you buy the insurance, debit the Prepaid Expense account to show an increase in assets. You might be wondering what type of account is a prepaid expense. As a reminder, the main types of accounts are assets, expenses, liabilities, equity, and revenue.