Which of the following best describes how prepaid expenses are adjusted at the end of an accounting period?

• A. A portion of the prepaid expense is transferred from an asset account to an expense account.
• B. Prepaid expenses are recorded as liabilities until used.
• C. The entire prepaid expense is written off as an expense immediately.
• 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. Initially, they are recorded as assets because they represent future economic benefits.
2. Recognize the need for adjustment: At the end of the accounting period, a portion of the prepaid expense that has been used or consumed must be transferred from the asset account to the expense account to reflect its usage during the period.
3. Determine the amount to adjust: Calculate the portion of the prepaid expense that has been used 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 used.
4. Record the adjustment: Debit the appropriate expense account to increase expenses and credit the prepaid expense asset account to decrease the asset balance. This ensures the financial statements accurately reflect the expense incurred during the period.
5. Verify the adjustment: Ensure the remaining balance in the prepaid expense account represents the unused portion that will be consumed in future periods, aligning with the matching principle in accounting.