Paddy Co purchased a 1 year insurance on 1 April 2024 for $24000. What adjustment entry will the Accountant record on 31st Dec 2024?

Question

BlackTom AI · Accepted Answer

We start by identifying the facts: Paddy Co bought a 1-year insurance policy on 1 April 2024 for 24000. This is a prepaid asset because the benefit extends over the year. By 31 December 2024, nine months have elapsed (April through December), so nine months of the policy have been consumed, leaving three months of prepaid insurance remaining (January to March 2025).

Now we evaluate each option:

Option a: Insurance Expense 18000 Dr; Prepaid Insurance 1800 Cr
- This option attempts to recognize the expense for the nine months used (nine months × 2000 per month = 18000), and reduce the prepaid asset by the same amount. The direction of the entries is correct ( debit the expense, credit the prepaid asset ), but the credited amount is shown as 1800 instead of the correct 18000. This discrepancy means the numeric values do not align with the actual consumption of the insurance for the nine months.

Option b: Insurance Expense 24000 Dr; Prepaid Insurance 24000 Cr
- This entry would record the full year’s expense and reduce the prepaid asset by the same amount, which is incorrect for 31 December 2024 since only nine months have expired. The expense should be 18000, not 24000.

Option c: Prepaid insurance 18000 Dr; Cash Cr 18000
- Debiting Prepaid Insurance increases the asset, which is the opposite of what should be done when recognizing insurance expense for the period. Also, it involves cash rather than adjusting the prepaid asset to reflect usage. This misstates both the account type and the source of the adjustment.

Option d: Insurance Expense 24000 Dr; Cash 24000 Cr
- This treats the entire payment as an expense and uses cash as the credit source, ignoring the prepaid nature of the asset and the fact that only nine months have expired. It overstates expense and ignores the asset remaining.

Analyzing the logic and the numbers, the correct treatment is to recognize the portion of the insurance that has expired (nine months) as an expense and reduce the prepaid asset by the same amount: Insurance Expense 18000 Dr; Prepaid Insurance 18000 Cr. This reflects proper matching of expense to the period in which the benefit is consumed and reduces the asset that prepay accounts for.

In summary, option a aligns with the correct accounting concept (expense recognition for the period and reduction of the prepaid asset), but note the provided numeric value in the credit should be 18000 to match the 18000 debit for nine months. The other options misstate either the period, the accounts affected, or the direction and amount of the entries.

FNDN Accounting 2025 STD O2

Paddy Co purchased a 1 year insurance on 1 April 2024 for $24000. What adjustment entry will the Accountant record on 31st Dec 2024?

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