At August 31, the end of the first month of operations, the usual adjusting entry transferring prepaid insurance expired to an expense account is omitted

At August 31, the end of the first month of operations, the usual adjusting entry transferring prepaid insurance expired to an expense account is omitted. Which items will be incorrectly stated, because of the error, on (a) the income statement for August and (b) the balance sheet as of August 31? Also indicate whether the items in error will be overstated or understated.

Answers:

a. Insurance expense (or expenses) will be understated. Net income will be overstated.

b. Prepaid insurance (or assets) will be overstated. Owner’s equity (Owner’s Capital) will be overstated.

The following errors took place in journalizing and posting transactions: a. Insurance of $18,000 paid for the current year was recorded as a debit to Insurance Expense and a credit to Prepaid Insurance.

The following errors took place in journalizing and posting transactions:

a. Insurance of $18,000 paid for the current year was recorded as a debit to Insurance Expense and a credit to Prepaid Insurance.

b. A withdrawal of $10,000 by Brian Phillips, owner of the business, was recorded as a debit to Wages Expense and a credit to Cash.

Journalize the entries to correct the errors. Omit explanations.


Answer:

a. The correction could be made with one or two entries as shown below.
Prepaid Insurance36,000         
Insurance Expense18,000         
Cash18,000         
or (reverses original entry)
Prepaid Insurance18,000         
Insurance Expense18,000         
Prepaid Insurance18,000         
Cash18,000         
b. Brian Phillips, Drawing10,000         
Wages Expense10,000