Multiple Choice
When preparing adjusting journal entries for prepaid expenses at the end of an accounting period, which of the following best describes the correct adjustment?
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3. Accrual Accounting Concepts
Introduction to Adjusting Journal Entries and Prepaid Expenses
Multiple Choice
Which of the following best describes how a business should account for prepaid insurance at the end of an accounting period?
A
No adjusting entry is needed because prepaid insurance is an asset and remains unchanged until the policy expires.
B
The entire amount of prepaid insurance should be expensed immediately when paid.
C
An adjusting journal entry should be made to transfer the portion of insurance that has expired from Prepaid Insurance to Insurance Expense.
D
Prepaid insurance should be recorded as a liability until the policy expires.
Verified step by step guidance1
Understand the concept of prepaid insurance: Prepaid insurance is an asset because it represents a payment made in advance for insurance coverage that will benefit future periods.
Recognize the need for adjusting entries: At the end of an accounting period, an adjusting journal entry is required to allocate the portion of prepaid insurance that has expired (used up) to Insurance Expense. This ensures that expenses are matched with the revenues they help generate, following the matching principle.
Determine the expired portion: Calculate the amount of prepaid insurance that has expired during the accounting period. This is typically done by dividing the total prepaid insurance by the number of months in the policy and multiplying by the number of months that have passed.
Record the adjusting entry: Debit Insurance Expense for the expired portion to reflect the cost incurred during the period. Credit Prepaid Insurance for the same amount to reduce the asset balance, as part of it has been used.
Verify the updated balances: After the adjusting entry, ensure that the Prepaid Insurance account reflects the remaining unexpired portion and the Insurance Expense account reflects the cost incurred during the period.
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