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Prepaid Insurance – Tired of Lumpy Expenses?

What if your board of directors looks at your profit and loss report each month and things generally look good. Then one month they see a big loss. “That’s because I paid $1,200 to renew the officers’ and directors’ insurance policy,” you explain.

One board member comments, “I was going to ask if we had this insurance because I didn’t see it on the report last month.”

In reality you had been incurring insurance expense all along; it just wasn’t reflected in the profit and loss report. You should record expense for insurance each month as you “use up” the policy.

Lumpy Expenses

Typically with insurance you pay the entire premium or up front or, in the case of liability and casualty insurance, you pay the premium in front-loaded installments. If you simply record these payments as expense when they are made, you end up with “expenses” that are very lumpy. (“Lumpy” is an official accounting term.)

Smooth Expenses

Now imagine this scenario. You pay the up-front insurance premium for the officers’ and directors’ policy of $1,200. Instead of posting the $1,200 to expense, you post it to Prepaid Insurance, an asset account on the balance sheet. Then you make a journal entry to move $100 from Prepaid Insurance to Insurance Expense on the profit and loss report. You continue to move $100 every month from the asset account to the expense account until you have used up the entire policy and brought the Prepaid Insurance account down to zero. Expense is smoothed out over the entire policy period.

(Hint: you can set up a memorized recurring journal entry in QuickBooks Online or QuickBooks Desktop to take care of this monthly entry on autopilot.)

Now when the board of directors looks at the profit-and-loss report each month they see $100 of expense for officers’ and directors’ insurance coverage. No more lumpy expenses! And no one needs to wonder whether or not you actually have this policy in effect. Also by properly amortizing Prepaid Insurance to expense each month, you are presenting your financial statements correctly in accordance with Generally Accepted Accounting Principles (GAAP).

Larger, Trickier Policies with Lots of Fees

We’ve found property and casualty insurance policies to be a bit trickier because you generally don’t make one big payment up front. Instead you make several payments that are front loaded toward the beginning of the policy. The same process applies – record insurance payments to a Prepaid Insurance account and make an entry to expense 1/12 of the total premium each month.

It may help to set up a separate Prepaid Insurance account for each policy; it makes it easier to determine the remaining prepaid balance on the books with respect to each policy. We’ve found that insurance companies love to load up payments with service fees, processing fees, late payment fees, pay-by-phone fees, pay online fees, you name it. They are as creative as banks at coming up with fees. All these fees are on top of your stated premium. Hence the amount you code to the prepaid insurance account can end up being a lot more than the premiums you are amortizing, leaving a balance in prepaid expense at the end of the policy. If you do incur an extra fee, try to expense it in the month it happens. If you accidentally code an extra fee to prepaid expense, the worst case scenario is that you expense the unamortized balance in the prepaid account at the end of the policy.

Get a Leg Up on Prepaids

That’s it! Not hard to change from lumpy to smooth expenses and delight your auditors at the same time. (We know you live to do that.) We include the accounts you need and detailed instructions for recording prepaid insurance and monthly insurance expense in QuickBooks To Go!, our soon-to-be-available online plug-and-play system for nonprofit accounting using QuickBooks Online. Or Desktop, if that’s your preference. If you think QuickBooks To Go! may help you, please contact us. Happy accounting!

 

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