Prepaid insurance can be classified as a current asset because it is used up or expires in a short period of time, usually one year, of the balance sheet date.
Explanation:
All assets, liabilities, and equity of a company are represented on the balance sheet. An asset is an economic resource that provides future benefits for the business. Prepaid expenses are assets that are paid in cash in advance and have benefits that apply over future periods.
Prepaid insurance is the portion of an insurance premium that has been paid in advance and has not been used within the period of time stated in the insurance contract and is supposed to be used in the future. While the prepaid amount has not expired, it is treated as an asset, which is supposed to be used or converted to cash over the period of the contract. In case the insurance covers a longer period of time, the portion of the payment is classified as a long-term asset. If the prepaid insurance is not fully used when financial statements are prepared, it is going to be an asset at the payment date. The transaction does not affect the company’s liabilities or shareholder’s equity.
Such assets as prepaid insurance are subject to an adjusting journal entry. If the adjustment was not recorded, assets on the balance sheet would be overstated by the amount transferred out of prepaid insurance, and expenses would be understated by the same amount on the income statement. The prepaid insurance account balance should be monitored throughout the year in order to report assets and expenses timely.