Question

For each separate case below, follow the 3-step process for adjusting the prepaid asset account at December 31. Step 1: Determine what the current account balance equals. Step 2: Determine what the current account balance should equal. Step 3: Record the December 31 adjusting entry to get from step 1 to step 2. Assume no other adjusting entries are made during the year. a. Prepaid Insurance. The Prepaid Insurance account has a $4,700 debit balance to start the year. A re- view of insurance policies and payments shows that $900 of unexpired insurance remains at year-end. b. Prepaid Insurance. The Prepaid Insurance account has a $5,890 debit balance at the start of the year. A review of insurance policies and payments shows $1,040 of insurance has expired by year-end. C.PrepaidRent.OnSeptember1ofthecurrentyear,thecompanyprepaid$24,000 for 2 years of rentfor facilities being occupied that day. The company debited Prepaid Rent and credited Cash for $24,000.

Answer 1

Concepts and reason

Transactions: Transactions are the events that happen in a business for a particular period. These transactions form base for the accounting. These transactions are recorded in the books of accounts which help to prepare the ledger accounts.

Journal entries: The transactions of an organization are recorded in the books of accounts through journal entries. The analyzation and journalizing of transactions is the second step in the accounting cycle. These journal entries are used to post the transactions into ledger.

Debit and credit rules for Journal entries: Assets, expenses, and losses should be debited to increase as they have a debit balance. To decrease the balance, these accounts should be credited. Liabilities, capitals, revenue, and gains should be credited to increase as they have a credit balance. To decrease the balance, these accounts should be debited.

Fundamentals

Adjusting entries: Adjusting entries refer to the entries passed prior to the issue of financial statements, to convert accounting records to the accrual basis of accounting. They are usually passed at the end of the accounting period.

Accrual basis of accounting: In this method, the entity recognizes revenue in books of accounts as and when the conditions pertaining to the revenues are fulfilled to earn it. It records expenses, as and when there is an obligation raised pertaining to the payment of expense incurred.

Prepaid insurance: Entities usually subscribe insurance to protect from losses against the risks. The insurance premium is usually paid for more than one accounting period. Therefore, the cash payment involves the expenses which are to be incurred for the further accounting periods.

The entities should record the portion of cash payments which are yet to be incurred as prepaid insurance. The prepaid insurance is reported under current assets in the balance sheet.

Prepaid rent: Prepaid paid rent refers to the amount paid by entity before the commencement of the rental period. The entity records such advance as prepaid rent and reports in balance sheet under current assets.

(a)

Step 1: Prepaid Insurance current balance is $4,700.

Step 2: Prepaid insurance actual balance is $900.

Step 3: Record the adjusting entry as shown below:

(b)

Step 1: Prepaid insurance current balance is $5,890.

Step 2: As given, the expired premium at the end of the year is $1,040.

The unexpired portion is $4,850 which is ($5,890 - $1,040).

Therefore, at the end of the year the actual balance of prepaid insurance is $4,850.

Step 3: Record the adjusting entry as shown below:

(c)

Step 1: The amount paid on September 1^st will be current balance of prepaid rent before recording the adjusting entry.

Therefore, the current balance of prepaid rent is $24,000.

Step 2: As given, the rent for a period of 2 years is paid on September 1^st. The monthly expense amounts to $1,000, which is $\left( {\frac{{\$ 24,000}}{{24{\rm{ months}}}}} \right)$ . The accounting period ends on December 31^st. The rent for the period of 3 months, which is September 1^st to December 31^st, should be recorded as rent expense.

The rent expense for 3 months amounts to $4,000, which is ${\rm{(\$ 1,000 \times 3 months)}}$ . The balance amount after recording the expense will be the account balance of prepaid rent.

Therefore, the actual balance of prepaid rent is

$\begin{array}{l}\\ = \left( {\$ 24,000{\rm{ }} - {\rm{ }}\$ 4,000} \right)\\\\ = \$ 20,000\\\end{array}$ .

Step 3: Record the adjusting entry for prepaid rent as shown below:

Ans: Part a

Part b

Part c