Question

On April 1, 2016, 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, 2016 adjusting entry? Insurance expense will increase $2,250. Prepaid insurance will decrease $750. Prepaid insurance will increase $2,250. Insurance expense will increase $750.

Answer 1

Insurance expense will increase $2,250

Step-by-step explanation:

the adjusting entry will recognize the expired insurance thus, it will increase the expense and decrease the prepaid.

a complete year is worth 3,000 so each month : 3,000 / 12 = 250

From April 1st to December 31th 9 montths has expired:

250 x 9 = 2,250 expired insurance.

the entry will be as follows:

insurance expense 2,250 debit (+expense)

prepaid insurance 2,250 credit (-assets)

Therefore the first option is correct.