Which of the following best describes how prepaid expenses are recorded in adjusting journal entries at the end of an accounting period?

• A. Prepaid expenses are increased and a revenue account is increased to reflect future benefits.
• B. Prepaid expenses are eliminated entirely from the books at the end of the period.
• C. Prepaid expenses are transferred directly to retained earnings.
• D. Prepaid expenses are reduced and an expense account is increased to reflect the amount used during the period.

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 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, following the matching principle in accounting.
3. Determine 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. Simultaneously, an expense account is increased to record the cost incurred.
4. Prepare the adjusting journal entry: The adjusting journal entry typically involves a debit to the relevant expense account (e.g., Rent Expense) and a credit to the prepaid expense account (e.g., Prepaid Rent). This ensures proper allocation of expenses to the current period.
5. Review the financial statement impact: After the adjustment, the expense is reflected in the income statement, reducing net income, while the prepaid expense account on the balance sheet is reduced, showing the remaining balance of the asset.