Rent-a-Wreck,Inc.paid $12,000 cash for a one-year insurance policy on November 1,2012.What adjustment should the company make before preparing its annual financial statements on December 31,2012?

Question

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The company needs to make an adjustment to recognize the portion of insurance that has been used up by the end of the year. As 2 months have passed between the purchase of the insurance policy and year-end, the amount of insurance that has been used up is $2,000 (2/12 of $12,000). Therefore, the company should decrease prepaid insurance (asset) by $2,000 and recognize insurance expense (expense) of $2,000.

Option A is incorrect because it does not recognize any insurance expense.

Option B is incorrect because it recognizes the entire insurance expense upfront, without considering the portion that has been used up during the year.

Option C is incorrect because it does not recognize the full amount of insurance expense that has been used up during the year.

Rent-A-Wreck,Inc