Question

On October 1 of Year 1 Lesikar Company paid $1,200 cash for an insurance policy that would provide protection for a one year term. Which of the following shows how the required adjustment on December 31, Year 1 will affect Lesikar's ledger accounts?

A. Assets = Liabilities + Stockholders' Equity
Prepaid Insurance = Accounts Payable
3,600 3,600

B. Assets = Liabilities + Stockholders' Equity
Cash + Prepaid Insurance =
(1,200) 1,200

C. Assets = Liabilities + Stockholders' Equity
Prepaid Insurance = Retained Earnings
1,200 (1,200)

D. Assets = Liabilities + Stockholders' Equity
Prepaid Insurance = Retained Earnings
(300) (300)

Answer 1

The correct ledger adjustment for Lesikar Company's prepaid insurance after three months will account for the consumed portion of the policy, which is $300. This will decrease the Prepaid Insurance asset and the Retained Earnings, effectively recognizing the insurance expense in the income statement.

Step-by-step explanation:

The question relates to how an adjustment entry on December 31 of Year 1 will affect Lesikar Company's ledger for a prepaid insurance expense. The correct adjustment will need to account for the insurance policy's value that has been used up during the period from October 1 through December 31, Year 1. Since the insurance was a one-year policy costing $1,200 and three months have passed, $300 of the insurance has been 'used' (which is one quarter of the cost, as there are 12 months in a year). The correct adjustment is represented in option D. Assets on the balance sheet will decrease by the amount of insurance expense that has been incurred, and the Stockholders' Equity will decrease correspondingly on the income statement as Insurance Expense. The entry will be a debit to Insurance Expense and a credit to Prepaid Insurance for $300.

Therefore, the correct adjustment on the ledger accounts should show:

Assets = Liabilities + Stockholders' Equity
Prepaid Insurance = Retained Earnings
(300) (300)