Which of the following statements is correct about prepaid accounts A Prepaid accounts are also called prepaid expenses and are considered assets. B Prepaid accounts are another name for accounts receivable and are reported as an asset. C Prepaid accounts are current expense accounts and are reported on the income statement. D Prepaid accounts are also called prepaid liabilities and are classified as liabilities.
The Correct Answer and Explanation is :
The correct answer is:
A. Prepaid accounts are also called prepaid expenses and are considered assets.
Explanation:
Prepaid accounts, commonly referred to as prepaid expenses, are payments made in advance for goods or services that will be received or consumed in the future. These are classified as assets on the balance sheet because they represent future economic benefits. Examples of prepaid accounts include prepaid rent, prepaid insurance, and prepaid subscriptions.
Why Prepaid Accounts Are Considered Assets:
- Economic Benefits: Prepaid accounts signify that a business has paid for goods or services it has not yet received, so these payments represent benefits that will be utilized in future accounting periods.
- Asset Nature: According to accounting principles, an asset is anything that provides probable future economic benefits, which prepaid accounts fulfill.
When Prepaid Accounts Become Expenses:
As the prepaid amounts are used up or as time passes, they are gradually converted into expenses. For example:
- If a company pays $12,000 for a year’s insurance in advance, the $12,000 is recorded as a prepaid expense (asset).
- Each month, $1,000 is recognized as an insurance expense, reducing the prepaid asset until it is fully expensed at the end of the year.
Why Other Options Are Incorrect:
- B: Prepaid accounts are not accounts receivable; accounts receivable refer to amounts owed to the business by customers.
- C: Prepaid accounts are not current expenses; they only become expenses as they are used up.
- D: Prepaid accounts are not liabilities because they represent payments made in advance, not obligations.
In summary, prepaid accounts represent payments made ahead of time for future use and are classified as assets until they are expensed.