Definition of Prepaid Insurance as a Short-term Asset
Prepaid insurance is usually a short term or current asset because insurance premiums are rarely billed for periods greater than one year. Annual or semiannual insurance premiums are typical. As the prepaid amount expires, the company will reduce the asset account Prepaid Insurance with a credit entry and will debit Insurance Expense. (If the company arranges for its insurance premiums to be paid monthly, it is possible to have no prepaid amount.)
Definition of a Short-term or Current Asset
For most industries, a company’s current assets are defined as cash and other assets that will turn to cash or will be used up or consumed within one year of the balance sheet date. If a company is in an industry where the operating cycle is longer than one year, the company’s current assets are cash and assets that will be converted to cash or be used up/consumed during the operating cycle.
Example of Prepaid Insurance
Assume that on December 1, a newly formed company pays $600 for insurance coverage for the six months ending on June 1. As of December 31, the company will report Insurance Expense of $100 and its current asset Prepaid Insurance will report $500. The prepaid amount informs the readers of the December 31 balance sheet that the company will not have to pay $500 in cash for insurance during the next five months.
