Gibson Company paid $12,000 on June 1, 2014 for a two-year insurance policy and recorded the entire amount as Insurance Expense. The December 31, 2014 adjusting entry is
A) debit Insurance Expense and credit Prepaid Insurance, $3,500.
B) debit Insurance Expense and credit Prepaid Insurance, $8,500.
C) debit Prepaid Insurance and credit Insurance Expense, $3,500
D) debit Prepaid Insurance and credit Insurance Expense, $8,500.

Question

Quizplus · Accepted Answer

The correct adjusting entry is to debit Prepaid Insurance and credit Insurance Expense for $8,500. This is because from June 1, 2014, to December 31, 2014, is 7 months, so 5 months of the insurance policy remains unexpired. The monthly cost is $12,000 / 24 months = $500 per month. Therefore, the unexpired portion is 5 months * $500 = $2,500, and the expense for the 7 months of 2014 should be $12,000 - $2,500 = $9,500. Since the entire amount was initially recorded as an expense, we need to adjust $8,500 ($12,000 initial recording - $3,500 for 7 months of expense) back to Prepaid Insurance.

Gibson Company Paid $12,000 on June 1, 2014 for a Two-Year