Question

Dinosaur Junior Corporation purchased a one-year insurance policy in January 2015 for $75,000. The insurance policy is in effect from May 2015 through April 2016. If the company neglects to make the proper year-end adjustment for the expired insurance.

a. Net income and assets will be understated by $50,000.
b. Net income and assets will be overstated by $50,000.
c. Net income and assets will be understated by $25,000.
d. Net income and assets will be overstated by $25,000.

Answer 1

b. Net income and assets will be overstated by $50,000.

Step-by-step explanation:

When an amount is paid in advance for insurance, the entries posted are

Debit Prepaid Insurance

Credit Cash account (with the amount prepaid)

As the expense is incurred, entries required would be

Debit Insurance expense

Credit Prepaid Insurance (with the amount incurred)

Expired insurance at year end = 8/12 × $75000

= $50,000

This would have been recognized as an expense. When not recognized, both net income and assets will be overstated by $50,000.