Final answer:
To correct the error of an unadjusted prepaid insurance, the company should debit Insurance Expense for $1,500 and credit Prepaid Insurance for $1,500, reflecting two months of insurance usage.
Step-by-step explanation:
In early November 2010, a company made a $4,500 advance payment for six months' insurance and debited Prepaid Insurance for the entire amount. If no adjusting entry has been made before the books are closed for the year, the company needs to account for the insurance expense that has been used up. Since the insurance coverage is for six months, by the end of December, two months of insurance would have been used up. The adjusting entry would involve debiting Insurance Expense and crediting Prepaid Insurance to reflect two months of insurance usage, which is $4,500 divided by 6 months equals $750 per month. Therefore, the adjustment will be for $750 times 2 months, totaling $1,500.
The entry would look like this:
- Insurance Expense - debit $1,500
- Prepaid Insurance - credit $1,500
This entry effectively moves the expense from an asset account to an expense account, aligning the company's financial records with the accrual basis of accounting. It ensures that expenses are recognized in the period in which they are incurred.