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?

1) Increase Insurance Expense, Decrease Prepaid Insurance
2) Increase Prepaid Insurance, Decrease Insurance Expense
3) Increase Insurance Expense, Increase Prepaid Insurance
4) Decrease Insurance Expense, Decrease Prepaid Insurance

Answer 1

The correct adjustment on December 31 of Year 1 for Lesikar Company's insurance policy is to increase Insurance Expense by $300 and decrease Prepaid Insurance by $300.

Step-by-step explanation:

On October 1 of Year 1, Lesikar Company paid $1,200 cash for an insurance policy that provides protection for a one-year term. By December 31 of Year 1, three months would have passed. When accounting for insurance, the period in which the insurance is actually utilized must be reflected as an expense. As such, the company needs to adjust its accounts to record the portion of the insurance that has been 'used up' during these three months.

The appropriate adjustment would be to increase Insurance Expense and decrease Prepaid Insurance in the ledger accounts. The calculation for the insurance expense would be $1,200 divided by 12 months, yielding $100 per month. For the three months that have passed by December 31, the insurance expense would be 3 x $100, which equals $300. This amount should be recognized as an expense, and the Prepaid Insurance account should be reduced by the same amount.

Therefore, the correct adjustment on December 31, Year 1, would be (1) Increase Insurance Expense, Decrease Prepaid Insurance.