What is prepaid insurance?

Prepaid insurance is the fee associated with an insurance contract that has been paid in advance of the insurance coverage period. Thus, prepaid insurance is the amount expended for an insurance contract that has not yet been used through the passage of the time period stated in the contract. Prepaid insurance is treated in the accounting records as an asset, which is gradually charged to expense over the period covered by the related insurance contract.

Prepaid insurance is usually charged to expense on a straight-line basis over the term of the related insurance contract. When the asset is charged to expense, the entry is to debit the insurance expense account and credit the prepaid insurance account. Thus, the amount charged to expense in an accounting period is only the amount of the prepaid insurance asset ratably assigned to that period.

Prepaid insurance is nearly always classified as a current asset on the balance sheet, since the term of the related insurance contract that has been prepaid is usually for a period of one year or less. If the prepayment covers a longer period, then you should classify the portion of the prepaid insurance that will not be charged to expense within one year as a long-term asset.

Prepaid insurance is commonly recorded in business, because insurance providers prefer to bill insurance in advance. In particular, the providers of medical insurance usually insist upon being paid in advance, so that a company must record an insurance payment at the end of one month as prepaid insurance, and then charge it to expense in the next month, which is the month to which the payment relates.

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