Which of the following best describes what happens to a prepaid expense at the end of an accounting period when adjusting journal entries are made?

• A. A portion of the prepaid expense is recognized as an expense on the income statement.
• B. The prepaid expense is recorded as a liability.
• C. The entire prepaid expense is refunded to the company.
• D. No adjustment is necessary for prepaid expenses at period end.

Answer: (A)

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 accounting periods. Examples include prepaid rent, insurance, or subscriptions.
2. Recognize the need for adjusting entries: At the end of an accounting period, adjusting entries are made to ensure that expenses are recognized in the period they are incurred, following the accrual basis of accounting.
3. Determine the adjustment process: A portion of the prepaid expense that has been used or consumed during the accounting period is recognized as an expense on the income statement. The remaining balance stays as an asset on the balance sheet.
4. Understand the journal entry: The adjusting journal entry involves debiting the expense account (e.g., Rent Expense) and crediting the prepaid expense account (e.g., Prepaid Rent) to reduce the asset and recognize the expense.
5. Review the incorrect options: The prepaid expense is not recorded as a liability, it is not refunded to the company, and adjustments are necessary at the end of the period to ensure accurate financial reporting.