On january 1, a company purchased a five-year insurance policy for $3,500 with coverage starting immediately. if the purchase was recorded in the prepaid insurance account, and the company records adjustments only at year-end, the adjusting entry at the end of the first year is:

Insurance expense Dr      $700

         Prepaid insurance                                        $700

(Being insurance expense recognized

for the year)    

Explanation:

Prepaid insurance is the part of premium that has been paid in advance. It has been paid but not accrued yet. The company following accrual accounting charge the amount paid in advance to prepaid insurance account. At the end of the year, adjustment entry is passed to recognize the portion of prepaid insurance for the current year by charging it to insurance expense.

In this case insurance premium of $3,500 for 5 years is paid in advance. Insurance expense per year is 3,500 / 5 = $700. In the current year $700 will be recognized as insurance expense. Journal entry is:

Particulars                         Debit                 Credit

Insurance expense           $700

     Prepaid insurance                                 $700

(Being insurance expense

recognized for the year)    

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