The balance in the Prepaid Insurance account after the adjusting entries have been recorded represents the:
A. cost of the insurance expired during the period
B. value of the insurance prepayment that remains to benefit future periods
C. cash paid for insurance of current and future periods
D. amount owed for insurance at the end of the accounting period
The correct answer and explanation is:
The correct answer is B. value of the insurance prepayment that remains to benefit future periods.
When an entity pays for insurance in advance, the payment is initially recorded as an asset under “Prepaid Insurance.” This represents a prepayment for insurance coverage that extends over a future period. As the insurance coverage is used, the cost is gradually transferred from the Prepaid Insurance account to the Insurance Expense account through adjusting entries.
At the end of an accounting period, the balance in the Prepaid Insurance account reflects the amount of insurance that has not yet expired. In other words, it represents the portion of the insurance premium that will provide coverage in future periods. This is why the balance left in the Prepaid Insurance account after adjusting entries represents the value of the insurance prepayment that remains to benefit future periods.
To elaborate, when insurance premiums are paid upfront, the expense is not recognized immediately. Instead, the amount paid is initially recorded as a prepaid asset because the company is essentially purchasing future insurance coverage. As time passes, the cost of the insurance coverage used during each period is recognized as an expense. This is done by making adjusting entries at the end of each period, which gradually reduce the balance in the Prepaid Insurance account while increasing the Insurance Expense account.
Therefore, the remaining balance in Prepaid Insurance after adjusting entries is the unexpired portion of the insurance premium that will be used in future periods. It is not related to the expired portion (A), the cash paid for insurance (C), or the amount owed (D).