M.A. from New Haven County, Connecticut writes:
Dear Mister Condo,
What is the proper accounting treatment for insurance expense? Our CPA firm debits prepaid insurance and credits insurance liability for the full amount of our three year cancelable policy with no penalty. Each month, insurance expense is debited and prepaid insurance is credited. Insurance liability is then debited and cash is credited. I disagree with this treatment since we pay monthly pro-rata with no penalty. Our balance sheet, in my opinion, should not record the prepaid insurance or the liability. No expenditures were made and therefore we should not account for insurance on the balance sheet. Who is correct?
Mister Condo replies:
M.A., I love a good condo accounting question. Since I am not an accountant, I asked Sam Tomasetti, CPA of Tomasetti, Kulas & Company, P.C. to give us an answer. Here’s what he had to say:
“As well thought out as your question is and with all the details you provided, I have several questions I would need to ask in arriving at an answer that fits your situation exactly so I think the best way to be of help is to describe the acceptable methods to use in accounting for insurance cost which will depend on the facts at hand.
First, I agree with the treatment of recognizing insurance expense only if the premiums are being paid in 36 equal payments and you can cancel the policy at any time.
Second, you can record all of the payments you make on the policy to the prepaid insurance account and on a monthly basis you would reduce the prepaid insurance and record the insurance expense over the 36 month term of the policy.
Third, the one apparently used by your CPA firm, takes a balance sheet approach which is to record the full 3 year premium as an asset (“prepaid insurance”) and as liability (“insurance payable”). The asset is reduced over the 36 month period by the portion of the expired policy (“Insurance expense”) and the liability is reduced as payments are made during the 3 year policy term. Although, the prepaid insurance and the insurance payable presented on the balance sheet don’t fit the standard definitions of an asset and liability, the net amount of the two accounts, as compared to the other method, often differ by an immaterial amount.”
Hope this helps!