Understanding the Situation
When the insurance premium paid in the previous year is not carried forward to the insurance account, it results in an understatement of expenses and an overstatement of profit in the current year. This discrepancy needs to be corrected through a rectifying journal entry.
Rectifying Entry
To correct this error, an adjustment entry must be made in the books of accounts. The rectifying journal entry would be:
- Debit: Insurance Expense Account
- Credit: Insurance Premium Payable Account (or another relevant account)
Explanation of the Rectifying Entry
- Debit Insurance Expense Account:
This increases the insurance expense for the current period, reflecting the correct amount that should have been recognized.
- Credit Insurance Premium Payable Account:
This acknowledges that the premium was paid in the previous year and should reflect as a liability or adjustment in the books.
Impact on Financial Statements
- Income Statement:
The rectifying entry will increase the expenses, thereby reducing the net profit for the current period, aligning it with the true financial position.
- Balance Sheet:
The adjustments will ensure that the liabilities and equity sections accurately depict the financial standing of the company.
Conclusion
It's crucial to correct such errors to maintain the integrity of financial statements and ensure accurate representation of the company’s financial health. Regular reviews of trial balances can help identify such discrepancies early on.