Prepaid insurance is the portion of an insurance premium that has been paid in advance and has not expired as of the date of the balance sheet. This unexpired cost is reported in the current asset account Prepaid Insurance.
As the amount of prepaid insurance expires, the expired cost is moved from the asset account Prepaid Insurance to the income statement account Insurance Expense. This is usually done at the end of each accounting period through an adjusting entry.
To illustrate prepaid insurance, let's assume that on November 20 a company pays an insurance premium of $2,400 for the six-month period of December 1 through May 31. On November 20, the payment is entered with a debit of $2,400 to Prepaid Insurance and a credit of $2,400 to Cash. As of November 30 none of the $2,400 has expired and the entire $2,400 will be reported as Prepaid Insurance. On December 31, an adjusting entry will debit Insurance Expense for $400 (the amount that expired: 1/6 of $2,400) and will credit Prepaid Insurance for $400. This means that the debit balance in Prepaid Insurance at December 31 will be $2,000 (5 months of insurance that has not yet expired times $400 per month; or 5/6 of the $2,400 insurance premium cost).
