Question

On July 1 of the current calendar year, Plum Co. paid $8,900 cash for management services to be performed over a two-year period beginning July 1. Plum follows a policy of recording all prepaid expenses to asset accounts at the time of cash payment. The adjusting entry on December 31 of the current year for Plum would include: Multiple Choice A debit to an expense and a credit to a prepaid expense for $2,225. A debit to a prepaid expense and a credit to an expense for $2,225. A credit to a liability and a debit to a prepaid expense for $2,225. A debit to a prepaid expense and a credit to Cash for $6,675. A debit to an expense and a credit to a prepaid expense for $6,675.

Answer 1

Answer:

A debit to an expense and a credit to a prepaid expense for $2,225

Explanation:

As plum company paid $8,900 for 2 years contract on July 1, the number of months expired at the end of the December 31 was 6 months (July to December).

When the company paid for that prepaid expense for 2 years (24 months), it recorded -

July 1 Prepaid expense (Debit)  $8,900

Cash    (Credit)  $8,900

As the accounting period ended on December 31, the expense expired for six months

Therefore, 6 months expense = $8,900 ÷ (6 × 24)

6 months expense = $2,225

Whenever the advance expense expired, the expense becomes debit and the asset (Prepaid expanse) will become a credit.

Debit expense               $2,225  

credit prepaid expense $2,225

Therefore, option A is correct.