Is prepaid insurance an asset or a liability? Clearing 2022

Is prepaid insurance an asset or a liability? Clearing 2022

Insurance protects the business from losses due to theft, vandalism, or legal action. Insurance policies extend over a given period, either several months or several years. The company pays the insurance premium when purchasing the policy. The amount paid applies to the provisions of the contract for the entire duration of the policy.

Purchase of insurance

Companies take out insurance policies for long periods. The insurance policy specifies the length of time that the insurance company provides benefits to the business. When the company takes out the insurance policy, the accountant registers a debit on Prepaid Insurance and a credit on Cash. The prepaid insurance represents an asset for the company since it will benefit from the advantages of the insurance policy for future periods. The accountant includes prepaid insurance with current assets on the balance sheet.

Insurance expiry date

Each month, part of the insurance benefit expires. The company benefited from the security provided by the insurance coverage for this month. At the end of the month, the company records the expiration of one month of insurance coverage. The accountant reduces the balance of the expiring portion’s prepaid insurance. The accountant records a debit for the insurance charge and a credit for the prepaid insurance. Insurance costs are operating costs and reduce the net result of the income statement.

Sale of insurance

On the other hand, insurance companies provide insurance coverage to professional clients. Insurance is the main activity of the company. When the insurance company sells an insurance policy, it owes the customer insurance coverage for the duration of the policy. The accountant records a cash debit and a credit to unearned insurance revenue. Unearned insurance revenue represents a liability to the insurance company and is recorded with current liabilities on the balance sheet.

Insurance income

Each month, a portion of the insurance coverage due to customers expires. At the end of the month, the insurance company accrued revenue from the expiration of this coverage. The accountant debits unearned insurance income and insurance credits. Insurance revenue is recognized with sales in the income statement.

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By Michael Caine

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