Which of the following statements about adjusting journal entries for prepaid expenses is true?

• A. Adjusting entries for prepaid expenses have no effect on the income statement.
• B. Adjusting entries for prepaid expenses increase assets and decrease expenses.
• C. Adjusting entries for prepaid expenses increase both assets and expenses.
• D. Adjusting entries for prepaid expenses decrease assets and increase expenses.

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 the future. Examples include prepaid rent, insurance, or subscriptions.
2. Recognize the need for adjusting entries: Adjusting entries are required at the end of the accounting period to allocate the portion of the prepaid expense that has been used or expired during the period. This ensures accurate financial reporting.
3. Analyze the impact on accounts: When adjusting for prepaid expenses, the asset account (e.g., Prepaid Insurance) is decreased to reflect the portion that has been used, and an expense account (e.g., Insurance Expense) is increased to record the cost incurred during the period.
4. Understand the effect on the financial statements: Adjusting entries for prepaid expenses decrease assets on the balance sheet and increase expenses on the income statement, which reduces net income for the period.
5. Apply the correct journal entry format: The adjusting journal entry typically involves a debit to the expense account (e.g., Insurance Expense) and a credit to the prepaid asset account (e.g., Prepaid Insurance) to reflect the usage of the prepaid amount.