300408 PREPAID ASSET 1A1

Question 1

Roro, Inc., paid $7,200 to renew its only insurance policy for three years on March 1, 20X1, the effective date of the policy. On March 31, 20X1, Roro’s unadjusted trial balance showed a balance of $300 for prepaid insurance and $7,200 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Roro’s financial statements for the 3 months ending March 31, 20X1?

Prepaid insurance: $7,000; Insurance expense: $500

Prepaid insurance: $7,300; Insurance expense: $200

Prepaid insurance: $7,000; Insurance expense: $300

Prepaid insurance: $7,200; Insurance expense: $300

Question #300408

Answer 1

This question indicates that on Roro’s unadjusted trial balance the full 3-year premium of $7,200 for the renewal of the policy has been expensed. The prepaid insurance account still contains $300 of unamortized premiums from the old policy. The accountant must make adjusting entries to achieve the following:

Expense the remaining premium of the old policy (DR Insurance Expense 300; CR Prepaid Insurance 300).
Transfer the premium for the new policy to the prepaid insurance account (DR Prepaid Insurance 7,200; CR Insurance Expense 7,200).
Amortize one month of expense on the new policy (DR Insurance Expense 200; CR Prepaid Insurance 200).
Calculation of account balances:

Monthly amortization = Policy cost / 36 months
= $7,200 / 36
= $200 / month

Prepaid insurance Policy 1-month
balance on 3/31/X1 = cost - amortization
= $7,200 - $200
= $7,000
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Insurance expense on 3/31/X1:
Amortization of prior policy $300
March amortization of renewal 200
Total expense on 3/31/X1 $500
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Question 2

2211.03

Answer 2

Working capital is the excess of current assets over current liabilities. Current assets consist of cash and other assets reasonably expected to be realized in cash or sold or consumed in operations within one year or an operating cycle, whichever is longer. Examples of typical current assets are as follows.

a. Cash (unrestricted)
b. Marketable debt and equity securities
c. Other short-term investments
d. Accounts and notes receivable
e. Trade installment receivables
f. Inventories
g. Other short-term receivables
h. Prepaid expenses

Prepaid expenses (e.g., prepaid insurance, prepaid taxes) are traditionally included in current assets because, without the prepayment, the acquisition of the “benefit” (e.g., insurance coverage) would require the use of cash or other current assets during the next year or operating cycle.

Question 3

Prepaid Asset

Answer 3

A prepaid asset is a cost paid in advance that entitles the entity to receive service in the current and future accounting periods. It is a current asset. Examples include insurance or rent paid in advance. A prepaid asset is usually amortized over interim (e.g., monthly) accounting periods.