How to Handle Insurance Expiration and Accounting Adjustments

As a small business owner or accountant, staying on top of various accounting tasks is crucial for maintaining accurate financial records. One such task is dealing with insurance expiration and making the necessary adjusting entries in your books. In this article, we’ll dive into the specifics of adjusting entries related to insurance expiration, using the example of insurance expired during May for $275.

Understanding Adjusting Entries

Before we delve into the insurance expiration scenario, let’s briefly discuss adjusting entries. Adjusting entries are accounting journal entries made at the end of an accounting period to ensure that the company’s financial statements accurately reflect the revenues and expenses for that period.

These entries are necessary because some transactions may have occurred but were not recorded during the accounting period, or the initial recording was incomplete or inaccurate. Adjusting entries help to match revenues and expenses to the correct accounting period, following the accrual basis of accounting.

Insurance Expiration and Adjusting Entries

Insurance policies are typically paid in advance, and the cost is recorded as a prepaid expense on the balance sheet. As the insurance coverage period elapses, the prepaid expense needs to be recognized as an expense in the appropriate accounting period. This is where adjusting entries come into play.

In the given scenario, the insurance expired during May is $275. This means that $275 worth of insurance coverage was used up or “expired” during the month of May. To accurately reflect this expense in the financial statements, an adjusting entry is required.

The adjusting entry for insurance expiration is as follows:

Date       Account Name                   Debit   CreditMay 31     Insurance Expense             $275           Prepaid Insurance                     $275

Let’s break down this entry:

1. Debit: The Insurance Expense account is debited for $275. This increases the expense account, which will be reflected in the income statement for the current accounting period.

2. Credit: The Prepaid Insurance account, which is an asset account on the balance sheet, is credited for $275. This reduces the prepaid insurance asset by the amount of insurance coverage that has expired.

By making this adjusting entry, you ensure that the insurance expense for May is accurately recorded in the income statement, and the remaining prepaid insurance balance on the balance sheet is correctly stated.

Importance of Adjusting Entries

Adjusting entries play a crucial role in maintaining accurate financial records and adhering to accrual-based accounting principles. Failing to make the necessary adjustments can lead to inaccurate financial statements, which can have serious consequences, such as:

• Misstated income or expenses, resulting in incorrect tax calculations and potential penalties.
• Incorrect assessment of the company’s profitability and financial performance.
• Misleading information for decision-making processes, such as budgeting, investing, or obtaining loans.

By consistently making adjusting entries, including those related to insurance expiration, you can ensure that your financial statements accurately reflect the company’s financial position and performance for the given accounting period.

Conclusion

Handling insurance expiration and making the necessary adjusting entries is an essential aspect of maintaining accurate financial records. The example of insurance expired during May for $275 demonstrates the process of recording an adjusting entry to recognize the insurance expense and adjust the prepaid insurance asset accordingly.

Remember, adjusting entries are crucial for adhering to accrual-based accounting principles and providing stakeholders with accurate financial information. By staying on top of these entries, you can ensure that your company’s financial statements reflect a true and fair view of its financial position and performance.