Problem:
Please help me revise my answer based on my instructor's comments to the following business issue.
You are an accountant working for an advertising agency and you are working on the adjusting entries for the year ending December 31st. You notice that the prepaid insurance account is too high, because the policy has now been used up based on time. You paid for another year on January 1st, so the December 31 balance did not require any adjusting. Is this accurate and what effect will this type of behavior have on the financial statements.
The prepaid insurance (an asset) is used up, and was never expensed properly. Each month or once, at the end of each year there needs to be a credit to insurance expense for whatever amount, and a debit to prepaid rent. In this way, the prepaid insurance account becomes less, and the expense (insurance expense) is used up, either monthly, or once at the end of the year, depending on if the company is including it in their monthly or annual adjustments for expenses.
You paid for another year on Jan. 1st. You can't not expense the previous year, and just leave it in there for the next year, even if the same amount was paid. If you did, and made no adjusting entries, you wouldn't show anything for insurance expense. You would be overstating assets for Dec. 31 (prepaid insurance), and understating expenses (insurance expense). Your balance sheet will show assets at the correct amount, since the amounts of insurance from year-to-year are the same, but it's not proper accounting, and the lack of expenses in insurance expense will cause your net profit to be overstated by the amount of what insurance expense should have been.
Most of what you have stated is correct, but I want you to think about part of your statement "there needs to be a credit to insurance expense for whatever amount, and a debit to prepaid rent." Is this accurate? Work through the entries for a minute and see if you would like to revise.