Question

On August 1, Brant's Bakery purchased a one-year hazard insurance policy and recorded the $12,000

premium to prepaid insurance. No adjusting entries have been made yet regarding this transaction. At its
December 31 year-end, Brant's Bakery would record which of the following adjusting entries?
a. Debit Prepaid Insurance $5,000, Credit Insurance Expense $5,000
b. Debit Insurance Expense $5,000, Debit Prepaid Insurance $7,000, Credit Accounts Payable $12,000
c. Debit Insurance Expense $5,000, Credit Prepaid Insurance $5,000
d. Debit Insurance Expense $7,000, Credit Prepaid Insurance $7,000

Answer 1

The correct adjusting entry at Brant's Bakery year-end for the expired portion of the insurance policy is to debit Insurance Expense $5,000 and credit Prepaid Insurance $5,000, reflecting that five months of the insurance coverage has been used.

Step-by-step explanation:

On August 1, Brant's Bakery purchased a one-year hazard insurance policy and recorded the $12,000 premium to prepaid insurance. By December 31, five months of the insurance coverage have elapsed. Therefore, Brant's Bakery needs to recognize insurance expense for the period that the insurance policy was in effect. This would require an adjusting entry to allocate the cost between prepaid expenses (an asset) and insurance expense (an expense on the income statement).

The correct adjusting entry is to debit Insurance Expense $5,000, which records the expense on the income statement and to credit Prepaid Insurance $5,000, which reduces the asset on the balance sheet by the amount that has been used. This action reflects the usage of five months of coverage (5/12 of $12,000).