Assume that you are the chief accountant at a small service company that prepare
ID: 2434768 • Letter: A
Question
Assume that you are the chief accountant at a small service company that prepares financial statements on December 31 of each year. You have a new staff member, Bethany Johnson, who is tasked with preparing journal entries for the company. While reviewing Bethany’s work, you come across the following scenario.On June 1, 2009, the company paid for property insurance on a newly purchased building. The insurance expires on May 31, 2010. Bethany recorded the following two journal entries regarding the insurance.
6/1/09 Prepaid Insurance 3,600
Cash 3,600
5/31/10 Insurance Expense 3,600
Prepaid Insurance 3,600
Write a memo to Bethany explaining the error that she made. In your memo, discuss the general purpose of adjusting journal entries, the financial statement effects of her error, and the proper entry that should have been made.
Explanation / Answer
The adjusting entry required on 31st December 209 should be: Insurance Expenses $2,100 Prepaid Expenses $2,100 Ms. Bathany, The adjusting entries are required to be made at the year-end to record the revenue and expenses for that year, which is still not taken into account. In this case, the Insurance has been taken for a year (12 months) from 1st June 2009 to 31st May 2010. On 31st Dec.2009, the business has already completed 7 months of insurance, from 1st June 2009 to 31st Dec. 2009 and now the balance period left is 5 months from 1st Jan 2010 to 31st May 2010. Hence the cost of insurance for these 7 months should be booked as an expnese. Hence the above adjusting entry is required.