Question

Garden Hospital paid a three-year insurance premium of $3,600 in advance on January 1, 20x1, debiting the $3,600 to the prepaid account. At the end of the year, the necessary adjusting entry was not made, and the omission was not discovered. What effect would this error have on total assets, total liabilities, and hospital net assets, as reported in the hospital's balance sheet for December 31, 20X1?

Answer 1

Journal entry for paying $ 3,600 as insurance premium for 3 years on January 1, 20X1 :

Date	Accounts	Debit	Credit
January 1, 20X1	Prepaid Insurance	$ 3,600
	Cash		$ 3,600

At the end of the year ( December 31, 20X1) the adjustment journal entry is as follows :

Date	Accounts	Debit	Credit
December 31, 20X1	Insurance expenses	$ 1,200
	Prepaid Insurance		$ 1,200
	[ $ 3,600 X 1/3]

If, adjustment entry for prepaid insurance had not made on the year end ( i .e December 31,20X1) , and omission was not discovered, then following will be the effects :-

Total assets = Total assets will be overvalued by $ 1,200. Because prepaid expenses of $ 1,200 still not credited for adjustment and remains in the assets in balance sheet .

Total liabilities = No effect on total liabilities of the hospital's balance sheet. Because adjustment journal entry for prepaid insurance doesn't contain any liability account in debit or in credit.

Net assets = { Total assets - Total liabilities }

Due to the omission of the adjustment entry for prepaid insurance, total assets gets overvalued by $ 1,200 and no effect found on total liabilities, so hospital's net assets also overvalued by $ 1,200.