Allied, Inc. bought a 3-year insurance policy on August 1 for $3,900. Assume no other adjusting entries have been done this fiscal year. The adjusting entry on December 31 would be:

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The insurance policy costs $3,900 for 3 years, which is 36 months. The monthly cost is $3,900 / 36 = $108.33. From August 1 to December 31 is 5 months, so the expense for 5 months is $108.33 * 5 = $541.65, rounded to $542. The adjusting entry should recognize this expense, so debit Insurance Expense and credit Prepaid Insurance for $542.