A payment for insurance on 1 June for $120 000, covering the period 1 June 2018 to 31 May 2019, was recorded as a prepayment. No adjusting entry was made at 30 June 2019. As a result:

Question

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The insurance payment of $120,000 covers a 12-month period. By 30 June 2019, the entire insurance period has been utilized, so there should be no prepayment remaining. However, if no adjusting entry was made, the prepayment account would still show the $120,000 as an asset, which is incorrect. The correct treatment would have been to expense the entire amount over the coverage period. Since the prepayment was not adjusted, it means the expense was not recognized, leading to profit being overstated by the amount that should have been expensed ($120,000 for the full year). However, since the question specifies the error was identified at the end of the period, the entire amount should have been recognized as an expense, leaving no balance in prepayments. Thus, the mistake leads to both profit and total assets being overstated by the monthly insurance cost ($120,000/12 = $10,000) that should have been expensed in June.

A Payment for Insurance on 1 June for $120 000