Question

On October 1 of Year 1, Wilburn Company paid cash for an insurance policy that would provide protection for a one year term. Which of the following shows how the required adjusting entry on December 31, Year 1, will affect Wilburn's financial statements?

1) Assets will decrease, and liabilities will decrease.
2) Assets will increase, and liabilities will increase.
3) Assets will decrease, and liabilities will increase.
4) Assets will increase, and liabilities will decrease.

Answer 1

When a company pays for an insurance policy that provides protection for a one-year term, an adjusting entry on December 31 will decrease assets and increase liabilities. Correct option is 3)

Step-by-step explanation:

When a company pays cash for an insurance policy that provides protection for a one-year term, it is considered a prepaid expense. On December 31 of Year 1, an adjusting entry is required to account for the portion of the insurance policy that has been used up. This adjusting entry will decrease the company's assets (specifically the prepaid insurance account) and increase its liabilities (specifically the insurance expense account) because the company has already used up a portion of the insurance coverage.

In this case, the correct answer is option 3) Assets will decrease, and liabilities will increase.