On May 1, 2005, a company purchased prepaid insurance, covering the next three years, for $10,800. The entire amount was debited to insurance expense at that time. On January 10, 2007, the error was discovered. The average income tax rate was 40 percent. The correction of prior years' error (including its tax effect) on January 10, 2007, is:

Question

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The prepaid insurance should have been amortized over three years. By January 10, 2007, 20 months of insurance had been used, leaving 16 months prepaid. The prepaid amount is $10,800 * (16/36) = $4,800. The tax effect is $4,800 * 40% = $1,920. The correction is $4,800 - $1,920 = $2,880 credit.

On May 1, 2005, a Company Purchased Prepaid Insurance, Covering