Question

if a firm has prepaid the insurance premium of $1200 in May for the whole upcoming year, then in June of the same month the CASH FLOW statement should have ...

1. Operating cash increased (+ $200)
2. Operating cash decreased (- $200)
3. Operating cash increased by X (+ $X) .. How much X ?
4. Operating cash decreased by Y (- $Y) ... How much Y ?
5. No effect at all

My Answer -

I think because Prepaid Insurance is current asset it is affecting cash flow by reducing it. But as month expires the asset starts reducing its value and actual operating expense starts flowing out on monthly installment basis (liquidates) ...

So it can be operating outflow accruing  for both months of May and June i.e. $100*2 = $200.

Which means option 2.

Is this answer and understanding correct? If not please explain?

Answer 1

Answer:

Prepaid insurance is a current asset, a decrease in current asset will appear as an increase in cash from operating activities.

Ans : Operating cash increased (+$200)

Explanation:

Here a prepaid insurance of $1200 in the month of may had previously reduced the cash balance and it affected the cash flow statement of May(Assumed to be paid on May 1st) by reducing the cash flow from operating activities without any expenditure incurred. Now at present in the month of June end the expense got incurred to the extent of $200 for two months which had reduced the balance of current asset previously created,( in real there is no cash outflow for the month of June, but we only incurred the expense), this indirectly increases the operating cash flow.

Thank you.