Question

On July of the current calendar year, Olive Co paid $7600 cash for management services to be performed over a two-year period beginning July 1. Olive follows a policy of recording all prepaid expenses to asset accounts at the time of cash payment. The adjusting entry on December 31 of the current year for Olive would Include:

Multiple Choice
a.A credit to a liability and a debit to a prepaid expense for $1,900.
b.A debit to a prepaid expense and a credit to an expense for $1,900.
c.A debit to an expense and a credit to a prepaid expense for hy 700.
d.A debit to an expense and a credit to a prepaid expense for $1,900.
e.A debit to a prepaid expense and a credit to Cash for $5,700.

Answer 1

The correct adjusting entry for Olive Co.'s prepaid expenses would be a debit to an expense account and a credit to a prepaid expense account for $1,900, which represents the cost of six months' worth of management services.

Step-by-step explanation:

The student is asking about the adjusting entry needed for a prepaid expense recorded by Olive Co. Given that Olive Co. paid $7,600 cash for management services covering a two-year period starting July 1 of the current year, and the question refers to the adjusting entry for December 31 of the same year, we need to account for six months of the service period.

To calculate the expense for six months, we divide $7,600 by 24 months (the total service period) to get the monthly rate, and then multiply by 6 (the number of months from July to December). This results in $1,900 ($7,600 / 24 months = $316.67 per month * 6 months = $1,900).

The appropriate adjusting entry would be a debit to an expense account to recognize the expense incurred and a credit to the prepaid expense account to reduce its balance accordingly. Therefore, the correct journal entry is a debit to an expense and a credit to a prepaid expense for $1,900 (option d). The entry reflects the usage of the service for half a year and the appropriate recognition of the cost of that service as an expense.