On July 31, 2018, a company purchased a two-year insurance policy for $27,000, paying cash and debiting Prepaid Insurance for the entire two-year premium amount. The adjusting entry on December 31, 2018 includes a:

Journal Entry will be as follow

DR.   Insurance Expense      $5,625

CR.   Prepaid Insurance        $5,625

Explanation:

On 31 July 2018 the advance Insurance has been paid and the prepaid insurance account has been debited and cash is credited. As a result the prepaid insurance is recorded as an asset. On December 31, 2018 five month has been passed, so according to accrual concept the expense should be recorded for this period. The adjusting entry requires an expense account of Insurance to debited and prepaid insurance account should be credited to transfer the accrued insurance expense from asset account to an expense account.

Total Insurance paid = $27,000 for two years

Insurance per month = $27,000 / 12 = $1,125

Insurance expense for five months of 2018 = $1,125 x 5 = $5,625

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