On July 1, 2021, JazzE Ltd. purchased a 3-year insurance policy and paid a premium of $60,000. JazzE has a December 31 year end. Under accrual accounting, which of the following statements best describes the effect of this transaction?

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Quizplus · Accepted Answer

When JazzE purchased the 3-year insurance policy, they paid $60,000 upfront. Since they have a December 31 year end, this means that they will have coverage for the period from July 1, 2021, to December 31, 2024. 
In accrual accounting, the expense should be recognized in the period when it is incurred, i.e., when the insurance coverage is used. Only the portion of the insurance premium that has been used during the year should be recognized as an expense, and the remaining should be recorded as an asset. 
Since the insurance policy covers a period of 3 years and JazzE has already used it for 6 months in 2021, the amount of insurance expense for 2021 would be $10,000 (=$60,000/3 *6/12). 
At the end of 2021, the balance in the prepaid insurance account would be $50,000 ($60,000 - $10,000). 
Similarly, for 2022, the insurance expense would be $20,000 (=$60,000/3), and the balance in the prepaid insurance account on December 31, 2022, would be $30,000 ($50,000 - $20,000). Therefore, choice C is the best answer.