Typically, insurance premiums are paid when coverage begins. So if you paid for an insurance policy during the accounting period, you probably bought coverage for several months or a year in advance. At the end of the accounting period, a prepaid expense account called prepaid insurance should be set up as an asset, reflecting insurance coverage for the future that you have already paid for. This can be done by making an adjusting entry in your general journal.
You paid an annual insurance premium of $1,200 on September 1, 2004, and charged the $1,200 to insurance expense in your cash disbursements journal. As of December 31, 2004, you have used up just four months ($400) of this coverage, and have eight months of coverage coming to you. This eight months of prepaid coverage ($800) represents an asset to you. Make the following general journal entry:
Prepaid insurance 800
Insurance expense 800
To set up eight months of prepaid insurance on 12/31/2004