Which statement most accurately describes the accounting treatment of prepaid expenses when preparing adjusting journal entries?

• A. Prepaid expenses are recorded as liabilities and recognized as revenue over time.
• B. Prepaid expenses are never adjusted at the end of the accounting period.
• C. Prepaid expenses are initially recorded as assets and then gradually expensed over time as the benefits are consumed.
• D. Prepaid expenses are immediately recorded as expenses when paid, with no need for future adjustments.

Answer: (C)

Verified step by step guidance

1. Understand the concept of prepaid expenses: Prepaid expenses are payments made in advance for goods or services that will be consumed or used in future periods. Examples include prepaid rent, insurance, or subscriptions.
2. Recognize the initial accounting treatment: Prepaid expenses are initially recorded as assets on the balance sheet because they represent future economic benefits.
3. Explain the need for adjustments: As the benefits of the prepaid expenses are consumed over time, the asset is gradually reduced, and the corresponding expense is recognized on the income statement to match the period in which the benefit is used.
4. Describe the adjusting journal entry: At the end of the accounting period, an adjusting journal entry is made to transfer the portion of the prepaid expense that has been consumed from the asset account to the expense account. This ensures compliance with the matching principle in accounting.
5. Clarify the correct statement: The correct accounting treatment is that prepaid expenses are initially recorded as assets and then gradually expensed over time as the benefits are consumed. This aligns with the accrual basis of accounting.