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drh3h3
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Joined: 28 Jan 2009
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Posted: 05 Feb 2009 at 19:47 \| IP Logged

Roro, Inc. paid $7,200 to renew its only insurance policy for three years on March 1, 1995, the effective date of
the policy. At March 31, 1995, Roro's unadjusted trial balance showed a balance of $300 for prepaid insurance
and $7,200 for insurance expense. What amounts should be reported for prepaid insurance and insurance
expense in Roro's financial statements for the three months ended March 31, 1995?
Prepaid Insurance
insurance expense
a. $7,000 $300
b. $7,000 $500
c. $7,200 $300
d. $7,300 $200

Explanation
Choice "b" is correct. The prepaid insurance reflected in the unadjusted trial balance would be fully expensed
and one month (March 1 through March 31) of the renewed policy cost would be expensed. Insurance expense
equals $500 ($300 plus $7,200/36 months). Prepaid insurance equals $7,000 ($7,200 × 35/36).

This is one of the few problems I can't understand even after reading the explanation...can someone help by explaining it in a way that makes sense?

Jams
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Joined: 26 Apr 2007
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Posted: 05 Feb 2009 at 20:51 \| IP Logged

i was having the same difficulty with this problem, though i am very bad at explaining, let me try it.
7200/3=2400/12=monthly expense for insurance, since its 3 years you divide it by 3 and to get a monthly figure divide by 12.
200+300 (unadjusted balance)=500 is your insurance expense.
since 200 is your monthly expense, $200 paid for the month march is not pre-paid, but the remaining balance is pre-paid which is 7200-200=7000.

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divyagovil1
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Joined: 30 Jan 2009
Location: India
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Posted: 06 Feb 2009 at 10:13 \| IP Logged

Jams is correct !!

The question is talking about 3 months ended Mar, 1995.

$300 unadjusted prepaid insurance balance -- adjust (reverse) it for Jan & Feb insurance expense as follows:-

Dr Insurance expense 300

Cr Prepaid Insurance 300

Now, company paid $7,200 insurance for 3 years on Mar 1, 1995.

Thus, $200 for Mar, 1995 and $7000 for future periods :-

Dr Insurance Expense 200

Dr Prepaid Insurance 7000

Cr Cash 7200

Thus, total insurance expense for 3 months ended Mar 31st, 1995 from the above 2 journal entries is $500

& Prepaid Insurance is $7000

Honestly speaking, I am a fan of journal entries and T-accounts. Thus, love to explain the answer in this way. Hope it doesn't bother you!!

Thanks!

Edited by divyagovil1 on 06 Feb 2009 at 10:15

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