Question

The adjusting entry for a prepaid expense always involves a(n):

a) Expense account and a liability account
b) Asset account and a liability account
c) Expense account and an asset account
d) Liability account and a revenue account

Answer 1

The adjusting entry for a prepaid expense involves a transaction between an asset account and an expense account, where the prepaid expense (asset) is decreased and the corresponding expense account is increased. Option c

Step-by-step explanation:

The adjusting entry for a prepaid expense involves reclassifying a portion of a prepaid expense as an actual expense over time. When you initially record a prepaid expense, it is recorded as an asset because it represents an item or service that will provide future economic benefit.

As time passes and the benefit is received (i.e., the service is used or the time period covered by the prepaid expense elapses), you need to adjust the entry to reflect that the asset has been 'used up' and an expense has been incurred.

The correct answer to the student's question is (c) Expense account and an asset account.

This adjustment decreases the prepaid expense (asset) account with a credit and increases the expense account with a debit. If, for example, a company had paid for 12 months of insurance in advance, each month it would debit the insurance expense account and credit the prepaid insurance (asset) account to account for one month's worth of insurance coverage used. Option c