Insurance premiums are paid as per the terms of the policy agreement between a company and the insurer. Normally, companies pay insurance premiums in advance as the one-year insurance tenure rarely matching with the company’s financial year. As such, there are instances of insurance premium getting paid after the end of the financial year for a company, involving more than one financial year and getting recorded in both financial years under different account headings.
To understand how to record a payment for insurance, one should be able to understand the difference between the two terms – prepaid insurance and insurance expense
Refers to insurance premiums paid in advance
- At the end of the accounting year, prepaid insurance is recorded as a current asset in the balance sheet of the company
- Will be reported after inventory under current assets as a subpart of prepaid expenses
- Refers to the amount paid by a company for undertaking an insurance contract.
- When the insurance amount expires, the balance under prepaid insurance is reduced by giving a debit to insurance expense and credit to prepaid insurance.
- The adjustment is done through an adjustment entry at the end of the accounting period.
- Adjustment entry helps ensure that proper insurance expense for the accounting period gets recorded in the profit and loss account.
Points to Note:
Payment for insurance is recorded based on the nature of its expense
Prepaid insurance is recorded as a current asset in the balance sheet and insurance expense as an expense in the profit and loss account