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

• A. A revenue account is debited and a prepaid asset account is credited.
• B. A prepaid asset account is debited and a cash account is credited.
• C. An expense account is debited and a prepaid asset account is credited.
• D. An expense account is credited and a prepaid asset account is debited.

Answer: (C)

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 in future accounting periods. These are initially recorded as assets because they represent future economic benefits.
2. Recognize the need for adjustment: At the end of the accounting period, the portion of the prepaid expense that has been used or consumed must be recognized as an expense. This ensures compliance with the matching principle, which states that expenses should be matched with the revenues they help generate.
3. Determine the accounts involved: The adjustment involves two accounts: the expense account (to record the consumed portion) and the prepaid asset account (to reduce the asset balance for the amount used).
4. Apply the adjustment entry: Debit the expense account to increase the expense and credit the prepaid asset account to decrease the asset. This reflects the consumption of the prepaid expense during the period.
5. Review the impact: After the adjustment, the financial statements will accurately reflect the expense incurred during the period and the remaining balance of the prepaid asset, if any, for future periods.