Accounting Fundamentals Certification (AFC) Practice Test 2025 – The Comprehensive All-in-One Guide to Exam Success!

Prepaid insurance is classified as an asset on the balance sheet under current assets because it represents payments made for insurance coverage that will be used over time in the future. The core function of prepaid insurance in accounting is to provide evidence of future benefits. When a business pays for insurance in advance, it is securing coverage for a designated period, and thus the payment represents a future benefit that will be consumed as time passes. As the insurance coverage period progresses, this prepaid amount is gradually expensed on the income statement, reflecting the consumption of that benefit over time.

This concept is important in accrual accounting, where expenses are recognized when they are incurred rather than when they are paid. Therefore, the proper accounting treatment for prepaid insurance ensures that expenses are properly matched with the revenues they help to generate, adhering to the matching principle in accounting. This treatment differentiates prepaid insurance from other accounting elements such as liabilities, cash flow tracking, or daily expense recording, which do not capture the essence of future benefits secured by the prepaid premium.