Multiple Choice
Which of the following statements best reflects the purpose of adjusting journal entries for prepaid expenses in financial accounting?
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3. Accrual Accounting Concepts
Introduction to Adjusting Journal Entries and Prepaid Expenses
Multiple Choice
In the context of adjusting journal entries for prepaid expenses, how is the amount of expense recognized for a prepaid insurance policy determined at the end of an accounting period?
A
By recording the entire prepaid amount as an expense immediately upon payment
B
By allocating the portion of the prepaid amount that has expired during the period as an expense
C
By recognizing the prepaid amount as revenue over the policy term
D
By deferring all expense recognition until the policy expires
Verified step by step guidance1
Understand the concept of prepaid expenses: Prepaid expenses are payments made in advance for goods or services to be received in the future. In this case, the prepaid insurance policy represents an asset until the coverage period expires.
Identify the portion of the prepaid insurance that has expired: At the end of the accounting period, determine how much of the insurance coverage has been used up. This is typically done by dividing the total prepaid amount by the policy term (e.g., months or years) to calculate the monthly or periodic expense.
Calculate the expense for the current period: Multiply the periodic expense (e.g., monthly expense) by the number of periods (e.g., months) that have passed during the accounting period to determine the amount of insurance expense to recognize.
Record the adjusting journal entry: Debit the Insurance Expense account for the amount calculated in the previous step to recognize the expense. Credit the Prepaid Insurance account for the same amount to reduce the asset balance.
Verify the remaining balance in the Prepaid Insurance account: After the adjusting entry, ensure that the remaining balance in the Prepaid Insurance account reflects the unexpired portion of the policy, which will be carried forward to the next accounting period.
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