The premium on a 3-year insurance policy expiring on December 31, year 3, was paid in total on January 1, year 1. Assuming that the original payment was initially debited to an expense account, and that appropriate adjusting entries have been recorded on December 31, year 1 and year 2, the balance in the prepaid asset account on December 31, year 2, would be
A. Lower than the balance on December 31, year 3
B. The same as the original payment.
C. The same as it would have been if the original payment had been initially debited to a prepaid asset account.
D. Zero.
Answer:C
C is corrent. Under either method the balance in the prepaid asset account on December 31, year 2, should be the unexpired portion of the policy. On 12/31/Y1, an adjusting entry would be made by debiting “Prepaid insurance” and crediting “Insurance expense” for two-thirds of the original payment (the unexpired portion of the policy). This would result in one-third of the payment being expensed. This entry would then be reversed on 1/1/Y2. At the end of year 2, an adjusting entry would again be made by debiting “Prepaid insurance” and crediting “Insurance expense” for one-third of the original payment (the unexpired portion of the policy). Since the reversing entry will not be made until 1/1/Y3, the prepaid asset account balance would be the same on 12/31/Y2 for this method as it would have been had the payment originally been debited to “Prepaid insurance” on 1/1/Y1.
