Final answer:
The purpose of adjusting prepaid assets is to recognize expenses over time, ensuring expenses match the period in which they are incurred. In the secondary loan market, loans are valued based on payment history and interest rate fluctuations, reflecting risk and economic conditions.
Step-by-step explanation:
Purpose of Adjusting Prepaid Assets
The purpose of adjusting prepaid assets is B. To recognize expenses over time. Prepaid assets are payments made in advance for goods or services to be received in the future. Adjustments are made to these assets as they are used or expired, transitioning the prepaid amount to an expense. For instance, suppose a company pays for a year’s worth of insurance upfront; each month, a portion of the prepaid asset will be adjusted to reflect that a month's worth of coverage has been used. This process ensures that the company's financial statements accurately reflect expenses in the periods they are incurred, aligning with the matching principle in accounting.
Assessing the Value of Loans in the Secondary Market
When buying loans in the secondary market, a bank or financial services company would assess the value of a loan based on several factors, such as the borrower's payment history and current economic conditions. For example:
A borrower who has been late on loan payments would make the loan less valuable, as there is a higher risk of default.
If interest rates in the economy have risen since the loan was made, the loan may be less attractive since new loans could be made at higher rates. Therefore, a lower price would be justified.
A loan to a firm that has just declared high profits is more robust and thus could command a higher price due to improved creditworthiness.
Conversely, if interest rates have fallen since the loan was made, the existing loan interest rate might be higher than current rates, making it more valuable and justifying a higher price.