Which of the following statements best describes the process of adjusting journal entries for prepaid expenses at the end of an accounting period?

• A. Prepaid expenses are reduced and a liability account is increased to record future obligations.
• B. Prepaid expenses are increased and a revenue account is increased to recognize earned income.
• C. Prepaid expenses are left unchanged until the end of the fiscal year, when they are written off entirely.
• D. Prepaid expenses are reduced and an expense account is increased to reflect the portion of the asset that has been 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 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, aligning with the accrual basis of accounting.
3. Identify the impact on accounts: When adjusting for prepaid expenses, the prepaid expense account (an asset account) is reduced to reflect the portion of the asset that has been used or expired during the period.
4. Increase the corresponding expense account: The portion of the prepaid expense that has been used is recorded as an expense in the income statement, increasing the relevant expense account (e.g., Rent Expense, Insurance Expense).
5. Record the journal entry: The adjusting journal entry typically involves a debit to the expense account and a credit to the prepaid expense account, ensuring the financial statements accurately reflect the consumed portion of the prepaid asset.