Which of the following statements is correct regarding the adjusting journal entry for prepaid expenses at the end of an accounting period?

• A. No adjusting entry is required for prepaid expenses if the cash payment was made in a previous period.
• B. Adjusting entries for prepaid expenses increase both assets and equity.
• C. Prepaid expenses are always recorded as expenses when cash is paid, so no adjusting entry is needed.
• D. An adjusting entry is made to transfer the portion of prepaid expenses that has been used up from an asset account to an expense account.

Answer: (D)

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. Initially, these payments are recorded as assets because they represent future economic benefits.
2. Recognize the need for adjusting entries: At the end of the accounting period, an adjusting entry is required to account for the portion of the prepaid expense that has been used or expired during the period. This ensures that expenses are recognized in the correct period according to the matching principle.
3. Determine the amount to adjust: Calculate the portion of the prepaid expense that has been used up during the accounting period. This can be done by dividing the total prepaid amount by the number of periods it covers and multiplying by the number of periods that have passed.
4. Record the adjusting journal entry: Debit the appropriate expense account to recognize the expense incurred during the period. Credit the prepaid expense (asset) account to reduce its balance, reflecting the portion that has been used.
5. Verify the impact on financial statements: The adjusting entry decreases the asset account and increases the expense account, which reduces net income and equity. This ensures accurate representation of the company's financial position and performance.