What Is Prepaid Insurance and Is It an Asset?

Prepaid insurance is considered a current asset and refers to paying your insurance premiums in advance in a lump sum. Prepaid insurance is considered a prepaid expense. Many businesses will have one or more prepaid expenses due to the way that some goods and services are sold, such as prepaid rent or when legal services are retained.

Continue reading to see examples of prepaid insurance and how it’s reflected on financial statements.

On This Page

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  What is Prepaid Insurance?

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  How Does Prepaid Insurance Work?

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  Accounting Steps to Record Prepaid Insurance

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  Is Prepaid Insurance Considered a Prepaid Expense?

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  FAQs

What is Prepaid Insurance?

Prepaid insurance refers to paying your insurance premiums in advance in a lump sum, usually for a six- or 12-month policy. Insurance providers often provide premium discounts to incentivize policyholders to make lump-sum payments on their insurance policy. This also helps insurance companies with customer retention, since customers may be less likely to switch carriers mid-policy if they’ve already paid upfront.

Prepaid Insurance Example

A company pays $1,000 in advance for general liability insurance with a 12-month policy term.

How Does Prepaid Insurance Work?

Depending on the policy, a business may pay their insurance premiums on a monthly, quarterly, or annual basis. When the business pays for the premiums upfront, they are paying in advance for the entire policy period. Therefore, the entire prepaid insurance expense is recorded on the “asset” side of the balance sheet.

The bookkeeper would create an initial journal entry that debits the lump-sum amount to the asset account for prepaid insurance and a credit of the same amount from the asset account for cash. This lump-sum amount is then amortized into smaller payments depending on the policy’s original payment frequency, which is recorded on the business’s income statement.

If premiums are charged monthly, the accountant should record two entries each month: one that credits the amortized amount from the prepaid insurance asset account and a second one that debits the same amount to the insurance premium expense.

How Is Prepaid Insurance Reflected on Financial Statements?

The balance sheet lists prepaid insurance as an asset. The entire cost of prepaid insurance is recorded on the asset side and is then amortized over the policy term.

When the insurance premium payment is ordinarily due, that expense is deducted from the asset side and moved to the expense side. This is recorded on the business’s income statement.

As a simplistic example, if you paid $1,200 for a 12-month insurance policy, you would see 12 entries of $100 being moved from the prepaid insurance asset account to the insurance expense (once each month).

Here’s a deeper look at what’s happening on your balance sheet and income statement:

When you prepaid for an insurance policy, you will create an entry in your balance sheet showing $1,200 being credited from your cash account and then the same amount being debited to your prepaid insurance account. This amount will be amortized over the next 12 months ($100 per month) and this entry will be recorded on your income statement.

At the end of the first month, you incur a $100 insurance expense to pay for coverage for the next month. To cover this charge, on your income statement, you will record an entry crediting the prepaid insurance account $100 and another entry debiting $100 to the insurance expense.

After this first expense, your balance sheet will show that there is $1,100 left in your prepaid insurance account. At the end of February, March and so on, your income statement will record another entry showing $100 leaving the prepaid insurance account to cover the insurance expense of $100 for coverage for the next month. Eventually, there will be zero dollars left in the prepaid insurance account because the policy term is over. You can then choose to prepay for insurance again and this process will repeat.

Accounting Steps to Record Prepaid Insurance

Follow these steps to ensure you’re recording the cost of prepaid insurance correctly in your accounting records.

1. Charge the insurance company's invoice to the account for prepaid charges.
2. List “Prepaid Insurance” as an asset on the balance sheet, recording the prepayment amount.
3. Determine the number of time periods over which the prepaid money will be amortized.
4. Indicate the amortization charge that will be made for each period.
5. Make an adjustment journal entry for each period that credits the prepaid insurance account and debits the insurance expense.
6. Compare the worksheet total to the balance of the prepaid expense account after full amortization.

Is Prepaid Insurance Considered a Prepaid Expense?

Prepaid insurance is considered a prepaid expense because you are paying upfront for a benefit your business will not immediately use. To help illustrate this point, let’s use a six-month insurance policy that charges premiums monthly. One premium payment pays for one month of coverage. If you pay for all six months in advance, you are technically not using the second, third, fourth, fifth or sixth month of coverage until you reach that point in your policy term. In other words, you are paying upfront for a benefit that will be used later.

However, prepaid insurance is usually classified as a current asset since the benefit is used quickly. Contrast this with a long-term asset, which may not be used until one year or further in the future.

Other Prepaid Expense Examples

The majority of businesses will have one or more prepaid expenses due to the way that some goods and services are sold. Other common examples of prepaid expenses may include:

• Prepaid rent: Similar to paying your insurance premiums in advance, you can also make a lump-sum payment for your lease.
• Retainer for legal services: When a business pays a retainer, it shows up on the balance sheet as a prepaid expense. Since the business has not yet reaped the benefits of the services, it is not immediately expensed. The business would record an expense and deduct the prepaid asset by the same amount as new invoices come in.

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