How to Adjust Insurance Policy Cost in Accounting Entries?

Understanding Insurance Expense Adjustments

Accounting for Insurance Expense: When a company purchases an insurance policy, the cost is initially recorded as a prepaid expense. As time passes, a portion of this prepaid expense is recognized as an expense in the income statement.

Calculation: The cost of the insurance policy purchased by Tumbler, Inc. is $3,700 for 4 years, which is equivalent to 48 months. To determine the monthly expense, we divide $3,700 by 48, resulting in approximately $77.25 per month.

Adjusting Entry: From August 1 to December 31, there are 5 months that have passed. Therefore, the total insurance expense for this period would be 5 months multiplied by $77.25, which equals $386.25. However, in accounting, we generally use whole numbers, so the amount is rounded down to $385.

Recording the Entry: To adjust for the insurance expense on December 31, Tumbler, Inc. would debit Insurance Expense for $385 and credit Prepaid Insurance for the same amount. This records the portion of the insurance cost that has been used up during the fiscal year.

Remaining Balance: The remaining balance in the Prepaid Insurance account represents the value of the insurance policy that has not been utilized yet and will be spread out over the remaining months of the policy period.

Understanding how to adjust insurance costs in accounting entries is crucial for accurately reflecting expenses and maintaining financial records in accordance with generally accepted accounting principles.