Final answer:
The company's payment of $2,400 for 1 year of insurance coverage is recognized as a prepaid asset and expensed over the coverage period. Insurance works on a principle where collected premiums must cover claims, company costs, and provide a profit margin. The example statement demonstrates how premiums from multiple policyholders are pooled to cover collective risks.
Step-by-step explanation:
On June 30, a company purchased 1 year of insurance coverage which started immediately, paying cash of $2,400. The true statement regarding this situation is that the company is prepaying for services that will be provided over the next 12 months. Accounting principles require that such payments be recorded as a prepaid asset initially and then expensed over the period that the insurance coverage applies. The essence of this transaction is that the company is protecting itself against potential future losses in exchange for the insurance premium paid.
Insurance companies rely on the concept that the premiums collected from policyholders are used to pay for the claims that arise. If each of the 100 drivers pays a premium of $1,860 annually, the insurance company would collect a total of $186,000. This amount is designed to cover the costs of accidents that the policyholders may encounter. Additionally, an insurance policy aims to balance the risk among high and low risk individuals to keep average premiums affordable for everyone, as demonstrated by mechanisms such as the individual mandate of the Affordable Care Act (ACA).