How to Account for Liability Insurance

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Businesses carry liability insurance to protect company assets from lawsuits when employees or customers are injured on business property or when employees are injured off property while conducting company business. Liability insurance premiums are usually paid in one lump sum in advance for coverage for the coming year, making the entire amount of the annual payment a prepaid expense of the business. The steps required to properly account for liability insurance depend on whether your company uses the cash or accrual method of accounting.

Things You'll Need

  • Cost of insurance policy

Accrual Method

  • Create an account called "prepaid insurance" in the "assets" section of the general ledger.

  • Create an account called "liability insurance expense" in the "expense" section of the general ledger.

  • Record the entire amount of the insurance expense paid as an increase to the prepaid insurance account. The accrual method of accounting requires a business to expense a prepaid item over the length of time it covers.

  • Record the entire amount of the insurance expense paid as a decrease to the checking account.

  • Divide the entire amount of the insurance expense paid by 12 to derive a monthly expense amount for the liability insurance.

  • Record a decrease to the prepaid insurance account at the end of the month equal to one month of expense calculated in Step 5.

  • Record an increase to the liability insurance expense account for one month of expense at the end of the month.

  • Continue recording one month of expense at the end of each month to the prepaid insurance account and the liability insurance expense account until the entire amount of the liability insurance has been expensed.

Cash Method

  • Create an account called liability insurance expense in the expense section of the general ledger .

  • Record the entire amount of the insurance expense paid as an increase to the liability insurance expense account. The cash method of accounting requires a business to recognize expenses when paid, so the entire cost of the policy is expensed when paid, rather than prorated over the year.

  • Record the entire amount of the insurance expense paid as a decrease to the checking account.

References

  • "Principles of Accounting"; A. Douglas Hillman, Richard F. Kochanek, Corine T. Norgaard; 1991
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