Insurance Expense refers to the expired premium paid by a business to an insurer. An insurer or insurance company undertakes specific risks thereby protecting the business from possible losses.
Insurance Expense is part of operating expenses in the income statement.
The amount paid to acquire a specific coverage is known as "premium".
Insurance agreements last for a certain period of time. Only the expired portion of the premium should be presented as "Insurance Expense". The unexpired part is presented as "Prepaid Insurance", an asset.
1. When the business buys an insurance coverage, the journal entry would be:
2. Upon the expiration of the contract or a part of it, the entry to transfer "Prepaid Insurance" to "Insurance Expense" would be:
The above entry is an adjusting entry and is required at the end of every accounting period. Companies who need accurate monthly financial statements should prepare monthly adjusting entries to make sure that the accounts are up-to-date.
On October 1, 2020, KILIN Corp. purchased a 1-year business insurance package from JC Insurance Company. KILIN paid $3,000 for the insurance coverage. The journal entry to record the transaction would be:
On December 31, 2020, the end of the accounting period, an adjusting entry should be prepared to transfer a portion of "Prepaid Insurance" to "Insurance Expense" since 3 months has already expired. The amount to be expensed would be $750 ($3,000 x 3/12). The adjusting entry would be:
At the end of the year, "Prepaid Insurance" would have a balance of $2,250 and "Insurance Expense" would be at $750. Adjusting entries can also be prepared monthly, especially if the company needs updated monthly account balances.
The entire premium may also be recorded initially as "Insurance Expense". The accounts must still be adjusted later to reflect to correct amounts for "Prepaid Insurance" and "Insurance Expense". The adjusting entry would be different (Debit: Prepaid Insurance 2,250; Credit: Insurance Expense 2,250) but will yield the same effect to the account balances.