Which of the following statements is correct about prepaid expenses?

• A. Prepaid expenses are immediately recognized as expenses when paid.
• B. Prepaid expenses do not require any adjusting journal entries at the end of the period.
• C. Prepaid expenses are recorded as liabilities until they are paid.
• D. Prepaid expenses are initially recorded as assets and expensed over time as the benefits are used.

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 received or used in the future. Examples include prepaid rent, insurance, or subscriptions.
2. Recognize the accounting treatment: Prepaid expenses are initially recorded as assets because they represent future economic benefits. They are not immediately recognized as expenses when paid.
3. Learn about the adjusting journal entries: At the end of the accounting period, an adjusting journal entry is required to allocate the portion of the prepaid expense that has been used or expired during the period. This ensures accurate matching of expenses to the period in which they are incurred.
4. Understand the expense recognition process: As the benefits of the prepaid expense are consumed over time, the asset is reduced, and the corresponding expense is recognized in the income statement. This follows the accrual basis of accounting.
5. Clarify the incorrect options: Prepaid expenses are not recorded as liabilities, as they represent future benefits rather than obligations. They also require adjusting entries to ensure proper expense recognition, and they are not immediately expensed when paid.