State BPA Fundamental Accounting Practice Exam

What is the normal balance of prepaid insurance?

1. Debit

2. Credit

3. Equity

4. Liability

The correct answer is: Debit

Prepaid insurance is classified as an asset on the balance sheet because it represents a payment that has been made in advance for insurance coverage that will be received in the future. Assets carry a normal debit balance, meaning that when you record an increase in an asset, you will debit the account. When insurance is prepaid, the expense has not yet been incurred, hence it is still considered an asset until the coverage period begins and benefits are consumed. This reflects the principle of matching expenses to revenues, recognizing expenses in the period they are incurred. As the coverage period progresses, the prepaid insurance amount will be gradually debited to the insurance expense account, thereby reflecting the use of that asset. Understanding that the normal balance of an asset account like prepaid insurance is a debit is key to properly managing and reporting financial statements accurately.