Difficulty: Easy

Average Score: 100%

The corporation paid $6,000 cash for a one-year insurance policy effective February 1. What is the impact on the January 31 balance sheet?

Rationale

Prepaid expenses increase by $6,000.

The payment of $6,000 for a one-year insurance policy represents an asset that will benefit the corporation over the course of the year. This transaction results in an increase in prepaid expenses on the balance sheet, reflecting the future economic benefit from the insurance coverage.

A (Prepaid expenses increase by $6,000) CORRECT

This choice accurately reflects the accounting treatment of the insurance policy payment. By paying cash for the insurance, the corporation recognizes an asset in the form of prepaid expenses, which will be expensed over the duration of the policy. Thus, the balance sheet would show an increase in prepaid expenses by the same amount.

B (Cash increases by $6,000) YOUR ANSWER

This option is incorrect because the transaction involves a cash outflow, not an inflow. The corporation is paying $6,000 for the insurance policy, which reduces the cash balance rather than increasing it.

C (Retained earnings increase by $6,000) YOUR ANSWER

This choice is also incorrect as retained earnings do not increase from this transaction. The payment for insurance affects the asset side of the balance sheet and does not impact retained earnings until the insurance expense is recognized over time.

D (Accounts payable increase by $6,000) YOUR ANSWER

This option is misleading because the payment for the insurance policy does not create a liability. Accounts payable would only increase if the company incurred an obligation to pay in the future, which is not the case here since the payment is made upfront.

Conclusion

In summary, the payment of $6,000 for a one-year insurance policy results in an increase in prepaid expenses on the January 31 balance sheet, reflecting the future benefits of the policy. The other choices incorrectly depict changes that do not occur as a result of this transaction, reinforcing the importance of understanding how asset purchases are recorded in accounting.

Related Questions

View all