-This question was submitted by a user and answered by a volunteer of our choice.
Prepaid Insurance is debited.
But before directly diving into the question, let me help you interpret the meaning of Prepaid Insurance, as this will help you understand the nature of this accounting term.
Meaning of Prepaid Insurance
Prepaid Insurance is the amount of insurance premium which has been paid in advance in the current accounting period. However, the related benefits corresponding to the insurance amount prepaid will be received in the next accounting period. In other words, the insurance premium is paid before it is actually incurred.
Prepaid Insurance is an example of Prepaid Expenses. It is presented as a “current asset” in the balance sheet.
Why is Prepaid Insurance debited?
To make you understand this question, it is important to familiarize you with both the Golden rules and Modern rules of accounting.
1. Modern rules of accounting
First, we will ascertain the reason why prepaid insurance is debited considering the modern rules along with the help of an example.
Prepaid insurance is an asset to the entity. Therefore, as per the modern rules of accounting for assets-
An increase in assets will be debited.
HP Inc. paid the insurance premium for its equipment’s amounting to 50,000 on 10/12/20×1. However, the amount of premium relates to the month of Jan 20×2 (Accounting period-Jan to Dec 20×1).
Journalizing this transaction in the books of HP Inc. on 10/12/20×1-
|Prepaid Insurance A/c||Debit||50,000||Debit the increase in asset|
|To Cash A/c||Credit||50,000||Credit the decrease in asset|
2. Golden rules of accounting
Now, let me help you interpret why prepaid insurance is debited correlating it with the golden rules and with the help of an example.
Prepaid Expenses are referred to as representative personal accounts (accounts that represent a certain person or group of people). Therefore, we need to follow the golden rules for personal accounts which states-
Debit the Receiver & Credit the giver
J P Morgan Inc. paid the insurance premium for all its furniture amounting to 100,000 on 15/03/20×2. However, the entire amount of premium paid relates to the month of April 20×2. (Accounting period-April 20×1 to March 20×2).
Journalizing this transaction in the books of J P Morgan Inc. on 15/03/20×2-
|Prepaid Insurance A/c||Debit||100,000||Personal A/c (Representative)||Debit the receiver of advance premium|
|To Cash A/c||Credit||100,000||Real A/c||Credit what goes out|
Prepaid Insurance will always be debited and not credited in the year of actual prepayment.