On April 1, Smart, Inc.paid $7,200 for an insurance premium on a three-year insurance policy.How does this transaction affect Smart's accounts?
A) Increase insurance expense and decrease cash by $7,200 each
B) Increase prepaid insurance and decrease cash by $7,200 each
C) Increase unearned insurance and decrease cash by $7,200 each
D) Increase prepaid insurance and decrease retained earnings by $7,200 each

Question

Quizplus · Accepted Answer

The payment of $7,200 for a three-year insurance policy is a prepaid expense. This means that Smart, Inc. has paid in advance for insurance coverage that it will use over the next three years. Therefore, this transaction will increase Smart's prepaid insurance account by $7,200 and decrease its cash account by the same amount. It will not impact Smart's insurance expense or unearned insurance accounts since the insurance premiums will be expensed as they are used over the next three years. Likewise, the transaction will not impact Smart's retained earnings account as this is a balance sheet transaction and does not affect the income statement.