On 12/31/24, the Cheboygan Company paid $2,000 of prepaid insurance and expensed the entire amount. The policy covered the period 1/1/25 to 12/31/26. The error was discovered on 1/10/26; the 2025 books are closed. The correcting journal entry will include what entry to 1/1/26 Retained Earnings?

The correcting journal entry will include:  A credit entry to 1/1/26 Retained Earnings.

Explanation:

On Payment the entry must have been :

Prepaid Insurance $2,000 (debit)

Cash $2,000 (credit)

By the end of year 2025, one year insurance will have expired and entries will be as follows :

Insurance Expense $,1000 (debit)

Prepaid Insurance $1,000 (credit)

But Instead the entry in error was made as :

Insurance Expense $,1000 (debit)

Cash $2,000 (credit)

This results in the Retained Earnings being Understated by $1,000 .

The amount of overstatement is corrected as :

Prepaid Insurance $,1000 (debit)

Retained Earnings $,1000 (credit)