(L.O. 5) The failure to properly record an adjusting entry for the expiration of insurance coverage will result in an (assume the account Prepaid Insurance was charged when the premiums were paid):

a. overstatement of assets and an overstatement of owners’ equity.

b. understatement of assets and an understatement of owners’ equity.

c. overstatement of assets and an overstatement of liabilities.

d. overstatement of liabilities and an understatement of owners’ equity.

Approach and Explanation: Analyze the effects of the adjusting entry that should have been made:

Dr. Insurance Expense xx Cr. Prepaid Insurance xx This entry increases expenses which decreases net income which gets closed into Retained Earnings which is a component of owners’ equity; therefore, owners’ equity will be overstated by the omission of the appropriate adjusting entry. The missing adjustment also reduces assets so assets are overstated by the failure to properly adjust the accounts. (Solution = a.)