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

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

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 or used in the future. Initially, these payments are recorded as assets because they represent future economic benefits.
2. Recognize the need for adjusting entries: At the end of the accounting period, an adjusting entry is required to allocate the portion of the prepaid expense that has been used or expired during the period. This ensures that expenses are accurately matched with revenues in accordance with the matching principle.
3. Determine the impact on accounts: Adjusting entries for prepaid expenses decrease the asset account (e.g., Prepaid Insurance, Prepaid Rent) to reflect the reduction in future benefits and increase the expense account (e.g., Insurance Expense, Rent Expense) to record the cost incurred during the period.
4. Understand the effect on financial statements: The decrease in assets is reflected on the balance sheet, while the increase in expenses is reported on the income statement, reducing net income for the period.
5. Apply the correct answer: Based on the explanation, the correct statement is 'Adjusting entries for prepaid expenses decrease assets and increase expenses,' as this aligns with the accounting treatment of prepaid expenses during the adjustment process.