Prepaid expenses confused

  • This topic has 6 replies, 4 voices, and was last updated 7 years ago by Anonymous.
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  • #191727
    Jasminekoko
    Participant

    Hi,

    I don’t understand why the answer is d. I did the T accouts and still confused about how to do this problem. Any suggestion is truly appreciated.

    Roro, Inc. paid $7,200 to renew its only insurance policy for three years on March 1, Year 5, the effective date of the policy. At March 31, Year 5, Roro’s unadjusted trial balance showed a balance of $300 for prepaid insurance and $7,200 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Roro’s financial statements for the three months ended March 31, Year 5?

    Prepaid insurance Insurance expense

    a. $7,000 $300

    b. $7,200 $300

    c. $7,300 $200

    d. $7,000 $500

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  • #643867
    mt3130
    Member

    $7,200/36 = 200. At March 31, Year 5, you would expense the $300 in your prepaid insurance, which would have presumably been for February Year 5, but was not removed from prepaids and expensed at the end of February. You will find that in the real world, many bookkeepers do not adjust prepaids each month lol. You would also expense $200, which is the cost of one month of insurance under the new policy, for the period of March 1 Year 5 through March 31 Year 5.

    Prepaid Insurance = 7,200 – 200 = 7,000

    Expense = 300 + 200 = 500

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    #643868
    Jasminekoko
    Participant

    Hi mt3130,

    Thank you very much.

    Can you please clarify what it means when it said that at Marh 31, year 5 unadjusted trial balance shows 7,200 for insurance expense? Many thanks again.

    #643869
    mt3130
    Member

    It means that when the company paid for the 3 years of insurance coverage, they expensed the entire amount in the current period instead of over the 3 year period that the insurance plan covers. Since only one month of the 36 month plan has occurred in the current period, you would only expense 1/36th of that amount, which is $200 (don't forget that you also have to expense the $300 relating to February Year 5).

    The entry I would make to fix the scenario you listed would be as follows:

    Debit Prepaid Insurance 6,700

    Credit Insurance Expense 6,700

    However, this gives a better picture of what is actually happening:

    To expense the $300 sitting in prepaid insurance that relates to February Year 5

    Debit Insurance Expense 300

    Credit Prepaid Insurance 300

    To reclassify prepaid insurance incorrectly recorded as insurance expense at March 1 Year 5

    Debit Prepaid Insurance 7,200

    Credit Insurance Expense 7,200

    To expense one month worth of prepaid insurance at March 31 Year 5

    Debit Insurance Expense 200

    Credit Prepaid Insurance 200

    When you collapse those last 3 entries together, you can see that they equal the first entry listed above. In the last three entries, the debits of insurance expense totaling $500 (initial balance of 7,200 + 300 – 7,200 + 200) and the net of the prepaid insurance changes results in a balance of $7,000 at March 31 (initial balance of 300 – 300 + 7,200 – 200).

    REG - 90 (08/2014) - Study Time = 6 days
    FAR - 89 (10/2014) - Study Time = 9 days
    BEC - 83 (11/2014) - Study Time = 4 days
    AUD - 89 (01/2015) - Study Time = 2 days

    Final score released - 2/4/15
    Application mailed - 2/5/15
    Licensed CPA - 2/12/15

    #643870
    Jasminekoko
    Participant

    Hi again mt3130,

    Wow, I got it. Thanks so much for your detailed explanation. I still have a lot more quetions that I have no clues of how to solve those. Can I send you questions for help if it's possible? Thanks very much for your understanding mt3130.

    #1521726
    warsidi
    Participant

    The beginning balance of prepaid insurance ($300) results from the previous period's adjusting entry (Dec 31, year 4) and it expires in Feb 28 year 5 (2 months). The expired insurance is debited as follows:

    Dr. Insurance Expense $200
    Cr. Prepaid Insurance $200

    It seems that the previous insurance policy costs only $150 per month.

    On March 1 year 5, the company directly records the insurance expense when it pays $7,200 for the insurance policy. The actual expense for March is actually $200 ($7,200/36). To correct the overstatement of expense, the insurance expense is reduced (credited) by $7,000 as follows:

    Dr. Prepaid Insurance $7,000 (new balance)
    Cr. Insurance Expense $7,000

    After the entries, the insurance expense will have debit balance of $500 ($300+$200), and the prepaid insurance will have debit balance of $7,000.

    #1521915
    Anonymous
    Inactive

    The person paid $7,200 to renew the policy on Mar 1. You have to look at this problem as if a non-accounting person only did the entry for purchasing the new insurance by incorrectly booking it to expense. YOU, the accountant, come in and realize that the old prepaid amount of $300 should be moved to expense since the old policy is expired and the new policy is starting. You then would adjust the incorrectly booked expense to an asset and amortize it for the amount of time that has passed which is one month. The journal entries would be as follows.

    Insurance Expense 300 -DR
    Prepaid Insurance 300 -CR
    (to get rid of the expiring insurance policy)

    Prepaid Insurance 7,200 -DR
    Insurance Expense 7,200 -CR
    (to adjust the incorrectly booked new insurance policy)

    Insurance Expense 200 -DR
    Prepaid Insurance 200 -CR
    (To expense one month of the new insurance policy ($7,200/36months=$200 per month)

    Sometimes its hard to understand what the question writers were getting at. I hope this helps!

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