PREPAID INSURANCE.
Do you understand how prepaid insurance is a deferred expense?This means we defer until later the RECOGNITION of theexpense…because we have not really incurred the expense yet.Think about this a minute. When we pay for a full year of insurancein advance of the time period of coverage, we record an asset,prepaid insurance. It is an asset because it is something we havethe right to receive – either the actual insurance coverage for thetime period that is not completed yet OR a refund of our unused $if we cancel it. So when we first pay out the $, we record adecrease to an asset (cash) and an increase to an asset (prepaidinsurance). We do not record expense because we have not “incurred”the expense because we have not yet “used” the insurance. At theend of January – before we close the period – we will record onemonth’s worth of expense by debiting and expense and crediting (andtherefore reducing) the prepaid asset for ½ of the amount we paidfor the year. Now we have expense of 1 month and only 11 months ofthe prepaid asset remaining.
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