Which of the following best describes a prepaid expense in the context of adjusting journal entries?

• A. An expense that has been incurred but not yet paid, recorded as a liability.
• B. A revenue that has been earned but not yet received, recorded as a receivable.
• C. A liability that has been settled in advance of the due date.
• D. An expense that has been paid in advance but not yet incurred, recorded as an asset until used.

Answer: (D)

Verified step by step guidance

1. Understand the concept of prepaid expenses: A prepaid expense occurs when a company pays for goods or services in advance of receiving them. These payments are initially recorded as assets because they represent future economic benefits.
2. Recognize the need for adjusting journal entries: Adjusting entries are made at the end of an accounting period to ensure that revenues and expenses are recognized in the period they are incurred, following the accrual basis of accounting.
3. Identify the correct description: A prepaid expense is an expense that has been paid in advance but not yet incurred. It is recorded as an asset on the balance sheet because the company has not yet used the goods or services it paid for.
4. Understand the adjustment process: As the prepaid expense is used or consumed, it is gradually expensed. This is done by reducing the prepaid expense account (asset) and increasing the expense account in the income statement.
5. Relate to the correct answer: The correct description aligns with the definition of prepaid expenses, which are recorded as assets until they are used or consumed, at which point they are expensed.