On April 1, 2024, the premium on a one-year insurance policy was purchased for $3,000 cash with the insurance coverage beginning on that date. The books are adjusted only at year-end. Which of the following correctly describes the effect on the financial statements of the December 31, 2024 adjusting entry?

Question

BlackTom AI · Accepted Answer

The situation describes an insurance policy purchased for 3000 cash on April 1, 2024, with coverage starting that date, and only year-end adjustments being made. To determine the adjusting entry on December 31, 2024, we must recognize how much of the 3000 prepaid insurance has expired by year-end.

First, calculate the portion of the policy that has expired by December 31: the policy term is 12 months (April 1 to March 31 of the following year), and 9 months have elapsed from April 1 through December 31. 9 months out of 12 is 9/12 = 0.75 of the policy. 0.75 × 3000 = 2250. This is the amount that should be expensed by December 31, 2024.

Now evaluate each option:

Option A: Prepaid insurance will increase $2,250. This is incorrect because the adjusting entry should reduce Prepaid Insurance (a debit to Insurance Expense and a credit to Prepaid Insurance), not increase it. The expense is recognized, not a rise in the remaining prepaid asset.

Option B: Insurance expense will increase $2,250. This is correct as it matches the amount of the policy that expired (9 months of 12), increasing the expense account.

Option C: Insurance expense will increase $750. This is incorrect; 750 would correspond to 3 months of the policy (3/12 × 3000), which is not the period elapsed by year-end.

Option D: Prepaid insurance will decrease $750. This is incorrect because the decrease should reflect the expiration of 2250 of the prepaid asset, not 750, and the decrease should be 2250, aligning with the amount expensed.

Putting it together, the adjusting entry would debit Insurance Expense for 2250 and credit Prepaid Insurance for 2250, aligning the expense with the period that has passed and reducing the prepaid asset accordingly.

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If $1,800 was paid for a one-year insurance policy, the adjustment to insurance expense at the end of the first month would be a:

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