How to Amortize Insurance in Accounting

Insurance protects your assets when the unexpected happens.

Insurance is amortized when its premium is paid in total upfront rather than periodically over the course of the policy. When a premium is paid in its entirety at the start of insurance coverage, the amount paid is recorded as a current asset account, "Prepaid Insurance." The insurance expense that applies to each month or period of the policy is recorded over time until the insurance policy expires. At the end of the accounting period, the amounts posted to insurance expense are reported on the income statement.

Instructions

1. Record a premium payment as "Prepaid Insurance." For example, a $1,008, 12-month insurance premium is paid. Record the payment by creating a journal entry that debits "Prepaid Insurance" and credits "Cash" or "Accounts Payable" for $1,008.

2. Calculate and record insurance expense. Identify the current asset account "Prepaid Insurance." Divide the amount paid by the term of the policy. If $1,008 is paid for a 12-month policy, the insurance expense is $84 a month. Record the expense by creating a journal entry that debits "Insurance Expense" and credits "Prepaid Insurance" for $84. This entry is recorded every month until the policy expires.

3. Report the insurance expense for the fiscal year or accounting period. At the end of the fiscal year, report the balance of the insurance expense account in the income statement as an operating expense deducted to arrive at net income for the accounting period. If the 12-month policy's term begins on a purchase date of Jan. 1, it will be expensed in its entirety by Dec. 31; the amount of insurance expense by Dec. 31 will be the entire $1,008 premium.

Tips & Warnings

• When insurance is paid on a monthly basis, the journal entry is a debit to "Insurance Expense" and a credit to "Cash". The prepaid insurance account is not used and does not apply.

References

• "Financial: CPA Exam Review"; DeVry/Becker Educational Development Corp.; 2009