Question

On October 1, 2014, Adams Company paid $4,800 for a two-year insurance policy with the insurance coverage beginning on that date. As of December 31, 2014, which of the following account balances are correct after adjusting entries have been made?A. Prepaid insurance $4,800, and Insurance expense $0.B. Prepaid insurance $0, and Insurance expense $4,800.C. Prepaid insurance $2,400, and Insurance expense $2,400.D. Prepaid insurance $4,200, and Insurance expense $600.

Answer 1

Answer:

Correct answer is letter D, Prepaid insurance $4,200, and Insurance expense $600

Explanation:

Using accrual basis method, revenue and expenses will be recognized when incurred whether paid or not.

The $4,800 is a 24 months policy, therefore we must compute the insurance expense applicable for the year covering from October 1, 2014  to December 31, 2014 (11 months)

An adjusting entry to recognize the expire portion of the insurance must be done at the year end in the amount of $600 while the balance of the prepaid insurance is $4,200.

$4,800 / 24 months = $200 x 3 months = $600 (insurance expense)

$4,800 - $600 = $4,200 (Prepaid insurance)