Question

Prepaid Insurance—Annual Adjustments

On April 1, 2017, Gitter Corp. purchases a 24-month property insurance policy for $79,200. The policy is effective immediately. Assume that Gitter prepares adjustments only once a year, on December 31.

Required:

1. Compute the monthly cost of the insurance policy.

$per month

2. Identify and analyze the transaction to record the purchase of the policy on April 1, 2017.

Activity

Operating

Accounts

Prepaid Insurance Increase, Cash Decrease

Statement(s)

Balance Sheet only

How does this entry affect the accounting equation?

If a financial statement item is not affected, select "No Entry" and leave the amount box blank. If the effect on a financial statement item is negative, i.e, a decrease, be sure to enter the answer with a minus sign.

Balance Sheet Income Statement

Stockholders' Net

Assets = Liabilities + Equity Revenues – Expenses = Income

No Entry

Insurance Payable

3. Identify and analyze the adjustment on December 31, 2017.

Activity

Operating

Accounts

Prepaid Insurance Decrease, Insurance Expense Increase

Statement(s)

Balance Sheet and Income Statement

How does this entry affect the accounting equation?

If a financial statement item is not affected, select "No Entry" and leave the amount box blank. If the effect on a financial statement item is negative, i.e, a decrease, be sure to enter the answer with a minus sign.

Balance Sheet Income Statement

Stockholders' Net

Assets = Liabilities + Equity Revenues – Expenses = Income

Cash

Prepaid Insurance

4. Assume that the accountant forgets to record an adjustment on December 31, 2017. Will net income for the year ended December 31, 2017, be understated or overstated?

Answer 1

Insurance Policy value		$       79,200
Time for which Insurance taken		24
Monthly cost		= $ 79200/24
		$   3,300.00
Journal Entry at the time of Purchase
Prepaid Insurance	$        79,200
Cash		$       79,200
Accounting Equation
Assets= Liabilities+ Share holders Equity
Prepaid Insurance (Asset Increase)	$        79,200
Cash paid (Asset Decrease)	$      -79,200
Hence no effect in Accounting Equation'
Adjustment entry at the year end
Insurance Expense	$        29,700
Prepaid Insurance		$       29,700
(being 9 months insurance expense accounted)
Accounting Equation
Assets= Liabilities+ Share holders Equity
Share holders Equity includes Retained Earnings also
Prepaid Insurance (Asset Decrease)	$        29,700
Insurance Expense (Retained Earnings reduces)	$      -29,700
If the accountant forgets to record adjustment entry, the entire amount will remain as asset and thereby not taking into account Expenses accrued.
Hence, net income will be overstated in the month Dec 2017.