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.
A is incorrect. 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.
A is incorrect. 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.
D is incorrect. 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.
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