State BPA Fundamental Accounting Practice Exam

Paying cash for insurance will result in a debit to?

1. Insurance expense

2. Prepaid insurance

3. Accounts payable

4. Cash

The correct answer is: Prepaid insurance

When a business pays cash for insurance, the transaction typically involves the purchase of a prepaid insurance policy, which is considered an asset because it represents a service that will be consumed over time. The correct accounting treatment is to create a debit to prepaid insurance. This reflects the value of the insurance coverage that will be used in future periods. By debiting prepaid insurance, the company acknowledges that it has acquired an asset that will provide future economic benefits. The corresponding credit in this transaction would be to cash, reflecting the outflow of cash from the company to pay for the insurance. In this context, the other choices do not accurately reflect the nature of the transaction. Insurance expense would be recorded over time as the coverage is consumed, while accounts payable would not apply since the payment is made immediately in cash. Therefore, debiting prepaid insurance accurately captures the impact of the cash payment on the company's financial statements.