Several situations could cause a credit balance in the asset account Prepaid Insurance. For example, let's assume a company's insurance has a cost of $600 every six months. As a result, the company decides to debit Prepaid Insurance when the amount is paid semiannually. It also prepares an automatic monthly adjusting entry to debit Insurance Expense $100 and to credit Prepaid Insurance for $100. If one of the $600 payments is debited to Insurance Expense (or another account) instead of Prepaid Insurance, the monthly adjusting entries will cause the balance in the Prepaid Insurance account to become a credit balance.

Another possibility is that the company simply failed to pay the insurance company and the monthly adjusting entries caused the balance in Prepaid Insurance to become a credit balance. Whatever the cause of the credit balance in Prepaid Insurance, the account balance needs to be adjusted before issuing a balance sheet. The Prepaid Insurance account must report the true amount that is prepaid (paid but not yet expired) as of the date of the balance sheet. If nothing is prepaid then the Prepaid Insurance account must show a zero balance. If an amount is owed to the insurance company, there should be a liability account with a credit balance for the amount owed as of the balance sheet date.

Because adjusting entries involve a balance sheet account and an income statement account, it is wise to also look at the amount being reported in the income statement account Insurance Expense. You should monitor both the Insurance Expense account balance and the Prepaid Insurance account balance throughout the year. The amount paid to the insurance company that has expired needs to be reported as an expense and the amount that has not yet expired needs to be reported as the asset Prepaid Insurance.