Question

An auditor discovered an error while conducting Black Inc.'s 2016 audit. No errors were corrected during 2015.

A 2 year insurance policy was purchased on April 30, 2015. This policy resulted in $24,000 being debited to Prepaid Insurance (on April 30, 2015). However, no adjustment was made on December 31, 2015 or on December 31, 2016.

Required:

Prepare the appropriate journal entries. Assume the 2016 book have not been closed but the tax entries have been completed. The tax rate for all years is 40%. Apply US GAAP.

Please be careful with how taxes are affected by this transaction.

Answer 1

Since the policy has been purchased so the appropriate entry would be:

April 30, 2015- Insurance policy a/c

To Bank a/c

But the company has wrongly debited Prepaid insurance, so

Adjusting entry would be;

April 30, 2015- Insurance policy a/c Dr 24000

To Prepaid Insurance a/c 24000

(Beinf prepaid insurance wrongly debited)

Since, prepaid insurance increased the tax value of the transaction by $24000*40%= $9600

So, putting the same into insurance policy investment account would result into decrease in tax of $9600.

So, adjusting entry for tax would be;

Provision for Tax a/c Dr 9600

To Profit and Loss a/c 9600

(being tax calculation reduced by $9600)