#19 Treatment of Prepaid Insurance

In accounting, we emphasize on ' Matching Principle': to match the expense incurred with the revenue generated in certain period. The idea behind is: there would be any direct or indirect cost incurred during the process of generating revenue within a specified period. The principle emphasize on matching the time frame of expense against the revenue, and the emphasis is on the recognition timing.

Assuming Company ABC entered a fire insurance contract for its building and stocks for a period of 2 years, starting from 1 Jan 07 ~ 31 Dec 08. Company ABC has paid the entire insurance cost of $200,000 in 1 Jan 07.

Apparently, the insurance cost incurred was expense over 2 years. Hence at the end of 31 Dec 07, we should only recognize $100,000 of insurance cost another $100,000 will be sitting in Prepayment account ( Asset). This is to match the expense incurred in the specified period.

To illustrate:

1) When the Company pay the insurance cost ( 1 Jan 2007):
Dr. Prepayment $200,000
Cr. Cash $200,000

2) At the end of 31 Dec 2007
Dr. Insurance Cost $100,000
Cr. Prepayment $100,000

3) At the end of 31 Dec 2008
Dr. Insurance Cost $100,000
Cr. Prepayment $100,000