Final answer:
The correct answer is C. Prepaid Insurance $750 and Insurance Expense $1,050. By December 31 of Year 1, the company would have recognized $1,050 as the insurance expense for the seven months of coverage used and still have $750 as prepaid insurance for the five months of coverage extending into Year 2.
Step-by-step explanation:
The Doe Company purchased a one-year insurance policy for $1,800 on June 1 of Year 1, and the policy is active until May 31 of Year 2. When reviewing expenses and prepayments at the end of Year 1 (December 31), the company would need to allocate the expense of the insurance policy across the period it covers. Since the policy covers 12 months, the monthly insurance cost is $1,800 divided by 12, which is $150 per month.
By December 31 of Year 1, seven months of the insurance policy have been used (June to December), equating to an insurance expense of $150 times 7, which is $1,050. The remaining five months of coverage extend into Year 2 (January to May), so the prepaid insurance amount at Year 1's end is $150 times 5, equal to $750.
At the beginning of Year 2, there would still be $750 of prepaid insurance, which will be expensed throughout the next five months of Year 2. Therefore, as of the financial statements for Year 2, the Doe Company would show $750 as prepaid insurance and $1,050 as the insurance expense for the Year 1 period.