The purpose is to allocate the cost to expense in order to comply with the matching principle. In other words, the amount allocated to expense is not indicative of the economic value being consumed. Similarly, the amount not yet allocated is not an indication of its current market value. If you want to minimize the number of adjusting journal entries, you could arrange for each period’s expenses to be paid in the period in which they occur. For example, you could ask your bank to charge your company’s checking account at the end of each month with the current month’s interest on your company’s loan from the bank. Under this arrangement December’s interest expense will be paid in December, January’s interest expense will be paid in January, etc.

• To transfer what expired, Insurance Expense was debited for the amount used and Prepaid Insurance was credited to reduce the asset by the same amount.
• The adjusting entry for prepaid insurance is usually made at the end of each accounting cycle or prior to the issuing of financial statements by a company.
• The adjusting entry ensures that the amount of rent expired appears as a business expense on the income statement, not as an asset on the balance sheet.
• The company must continue to make appropriate journal entries to apportion the prepaid insurance expense according to the time period during which the expense will continue to accrue.
• One objective of the adjusting entry is to match the proper amount of insurance expense to the period indicated on the income statement.
• We’ve outlined the procedure for reporting prepaid expenses below in a little more detail, along with a few examples.

Table of Contents

You prepaid a one-year insurance policy during the month and initially recorded it as an asset because it would last for more than one month. By the end of the month some of the insurance expired, so you reduced the value of this asset to reflect what you actually had on hand at the end of the month ($1,100). To prepaid insurance adjusting entry transfer what expired, Insurance Expense was debited for the amount used and Prepaid Insurance was credited to reduce the asset by the same amount. Any remaining balance in the Prepaid Insurance account is what you have left to use in the future; it continues to be an asset since it is still available.

Adjusting entries for prepaid insurance examples

Since the Accumulated Depreciation account was credited in the adjusting entry rather than the Equipment account directly, the Equipment account balance remains at $6,000, its cost. A fixed asset is a tangible/physical item owned by a business that is relatively expensive and has a permanent or long life—more than one year. Its initial value, and the amount in the journal entry for the purchase, is what it costs.

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It refers to the portion of the outstanding insurance premium paid by the company in advance and is currently not due. An interest billing may arrive late from the bank and so a company may accrue this expense. The majority of loans include interest charges that depend on the amount borrowed, the interest rate, and the length of the borrowing period. The total amount of interest on a loan is calculated as Principal amount x Rate x Time. A related account is Supplies Expense, which appears on the income statement. The amount in the Supplies Expense account reports the amounts of supplies that were used during the time interval indicated in the heading of the income statement.

Accrual adjustments

The balance sheet dated December 31 should report the cost of five months of the insurance coverage that has not yet been used up. Since it is unlikely that the $2,400 transaction Bookkeeping for Veterinarians on December 1 was recorded this way, an adjusting entry will be needed at December 31, 2023 to get the income statement and balance sheet to report this accurately. When the insurance premiums are paid in advance, they are referred to as prepaid. The amount of the insurance premiums that remain prepaid at the end of each accounting period are reported in the current asset account, Prepaid Insurance. The balance in this account will be combined with the balances in other prepaid expense accounts and will be listed on the balance sheet as prepaid expenses.

Deferral of Expenses

In this case, assume that the equipment depreciates at a rate of payroll $100 per month, which is determined by dividing its cost of $6,000 by 60 months (five years). After 12 full months, at the end of May in the year after the business license was initially purchased, all of the prepaid taxes will have expired. If the company would like to continue to do business in the upcoming year, it will have to prepay again. After 12 full months, at the end of May in the year after the rent was initially purchased, all of the prepaid rent will have expired. If the company would like to continue to occupy the rental property, it will have to prepay again. In the context of accounts receivable it is the amount of accounts receivable that is expected to be collected.

Accumulated Depreciation – Equipment is a contra asset account and its preliminary balance of $7,500 is the amount of depreciation actually entered into the account since the Equipment was acquired. The correct balance should be the cumulative amount of depreciation from the time that the equipment was acquired through the date of the balance sheet. A review indicates that as of December 31 the accumulated amount of depreciation should be $9,000. Therefore the account Accumulated Depreciation – Equipment will need to have an ending balance of $9,000. The income statement account that is pertinent to this adjusting entry and which will be debited for $1,500 is Depreciation Expense – Equipment. When a company prepays for an expense, it is recognized as a prepaid asset on the balance sheet, with a simultaneous entry being recorded that reduces the company’s cash (or payment account) by the same amount.

However, a count of the supplies actually on hand indicates that the true amount of supplies is $725. This means that the preliminary balance is too high by $375 ($1,100 minus $725). A credit of $375 will need to be entered into the asset account in order to reduce the balance from $1,100 to $725. It is possible for one or both of the accounts to have preliminary balances.