[ayden2008]

On April 1, Smart, Inc. paid $7,200 for an insurance premium on a three-year insurance policy. How does this transaction affect Smart's accounts?

Increase insurance expense and decrease cash by $7,200 each
Increase prepaid insurance and decrease cash by $7,200 each
Increase unearned insurance and decrease cash by $7,200 each
Increase prepaid insurance and decrease retained earnings by $7,200 each

[pready]

Think of the transaction. You are purchasing an insurance policy for 3 years at a total price of $7,200. So what accounts are being affected. Cash because you paid cash and Prepaid Insurance because you are purchasing insurance to be used in the future. Now how are those accounts being affected. You paid cash means you are decreasing cash, which is a Credit. Also you are increasing Prepaid Insurance because you are increasing the amount to bee used in the future, which means a Debit.

Based on your choices, insurance expense is not affected because you have not your insurance yet. Unearned Insurance is not correct because you are purchasing insurance, not selling insurance. Retained Earnings is not affected because you are not dealing with any transaction that affects equity in the company like net income or dividends.