Question

At the end of the month, Sebastian’s Construction Services had now used up one month of the 12 month insurance policy in the transaction contained in Question 1 Part A above.

Instructions:  Record the adjusting entry for Sebastian’s Construction Services. (4 marks)

Answer 1

Prepaid Insurance:

Insurance is generally prepaid as companies may purchase it on a six-month, one-year or multiyear term. The total amount of prepaid insurance is not recorded as an immediate expense at the time of the purchase when the insurance has not been used. The insurance coverage expires only with the passage of time. Thus, the total amount of cash spent on the insurance premium is not an expense in the current period. Companies simply have exchanged cash for the right to certain insurance coverage in the future..

Asset and Expense:

While expired insurance in each accounting period is recorded as an expense and reported in the income statement, total prepaid expense is recorded as an asset at the time of the purchase and reported on the balance sheet. However, as the insurance expires over time, the amount of prepaid expense as an asset decreases.

Journal Entry:

Companies use two sets of journal entries to record the insurance-related transactions, involving both prepaid insurance and expired insurance. When companies initially pay for the total insurance premium, a debit is entered to the asset account of prepaid insurance and a credit entered to the cash account for the cash spent. As the insurance expires over time, companies debit the expense account of expired insurance and credit prepaid insurance to reduce the balance in the asset account. At the end of the insurance term, the account of prepaid insurance should have a zero balance.

What ever the information provided to you is for knowhow purpose only, By applying above concept to the given data, journal entry is as follows :

As per information given in the data, adjusting entry for prepaid insurance in the books of construction services are recorded recorded as follows:

At the time of initial stage :

Prepaid insurance a/c Dr xxx

To Cash a/c xxx

At the end of every month :

Insurance(Expense)a/c Dr xxx

To Prepaid insurance a/c xxx