Final answer:
Creek Co. should adjust its financial statements by classifying the insurance premium payment as a prepaid expense for the years not yet covered and expense it throughout coverage. This aligns with the matching principle, ensuring expenses are recognized in the periods they benefit.
Step-by-step explanation:
When Creek Co. discovered that an insurance premium that was entirely expensed in year 7 covered the period from January 1 of year 7 through January 1 of year 9, accounting principles required them to adjust their financial statements. The insurance premium should not have been fully expensed in year 7 as it relates to multiple accounting periods. Instead, it should be classified on the balance sheet as a prepaid expense for the portion of the premium that applies to the future periods (years 8 and 9). Each year, the relevant portion of the premium would be recognized as an expense, aligning the expense recognition with the period in which the insurance coverage is applicable.
This process is consistent with the matching principle in accounting, ensuring that expenses are matched with the revenues of the corresponding period. Hence, for years 8 and 9, the financial statements would reflect the insurance premium expense on a prorated basis as the services are consumed rather than as a lump sum in the year the payment was made.
Creek Co.'s financial statements need to be amended to correct the premature expensing of the insurance premium, and the accounts need to reflect the appropriate allocation of insurance costs over the periods benefiting from the insurance coverage.