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AdjustingEntries
Thereismoretothemeasurementofbusinessincomethanmerelyrecordingsimplerevenueandexpense
transactionsthataffectonlyasingleaccountingperiod.Certaintransactionsaffecttherevenueor
expensesoftwoormoreaccountingperiods.Thepurposeofadjustingentriesistoassigntoeach
accountingperiodappropriateamountsofrevenueandexpense.Forexample,OvernightAutoService
purchasedshopsuppliesthatwillbeusedforseveralmonths.Thus,anadjustingentryisrequiredto
recordtheexpenseassociatedwiththeshopsuppliesthatOvernightuseseachmonth.
LO41
LO41
LEARNINGOBJECTIVE
Explainthepurposeofadjustingentries.
THENEEDFORADJUSTINGENTRIES
Forpurposesofmeasuringincomeandpreparingfinancialstatements,thelifeofabusinessisdivided
intoaseriesofaccountingperiods.Thispracticeenablesdecisionmakerstocomparethefinancial
statementsofsuccessiveperiodsandtoidentifysignificanttrends.
Butmeasuringnetincomeforarelativelyshortaccountingperiodsuchasamonthorevenayear
posesaproblembecause,asmentionedabove,somebusinessactivitiesaffecttherevenueandexpenses
ofmultipleaccountingperiods.Therefore,adjustingentriesareneededattheendofeachaccounting
periodtomakecertainthatappropriateamountsofrevenueandexpensearereportedinthecompany's
incomestatement.
Forexample,magazinepublishersoftenselltwoorthreeyearsubscriptionstotheirpublications.Atthe
endofeachaccountingperiod,thesepublishersmakeadjustingentriesrecognizingtheportionoftheir
advancereceiptsthathavebeenearnedduringthecurrentperiod.Mostcompaniesalsopurchase
insurancepoliciesthatbenefitmorethanoneperiod.Therefore,anadjustingentryisneededtomake
certainthatanappropriateportionofeachpolicy'stotalcostisreportedintheincomestatementas
insuranceexpensefortheperiod.Inshort,adjustingentriesareneededwhenevertransactionsaffectthe
revenueorexpensesofmorethanoneaccountingperiod.Theseentriesassignrevenuestotheperiodin
whichtheyareearned,andexpensestotheperiodsinwhichrelatedgoodsorservicesareused.
Intheory,abusinesscouldmakeadjustingentriesonadailybasis.Butasapracticalmatter,theseentries
aremadeonlyattheendofeachaccountingperiod.Formostcompanies,adjustingentriesaremadeona
monthlybasis.
TYPESOFADJUSTINGENTRIES
LO42
LO42
LEARNINGOBJECTIVE
Describeandpreparethefourbasictypesofadjustingentries.
Thenumberofadjustmentsneededattheendofeachaccountingperioddependsentirelyuponthenature
ofthecompany'sbusinessactivities.However,mostadjustingentriesfallintooneoffourgeneral
categories:1
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1. Convertingassetstoexpenses.Acashexpenditure(orcost)thatwillbenefitmorethanone
accountingperiodusuallyisrecordedbydebitinganassetaccount(forexample,Supplies,
UnexpiredInsurance,andsoon)andbycreditingCash.Theassetaccountcreatedactually
representsthedeferral(orthepostponement)ofanexpense.Ineachfutureperiodthatbenefits
fromtheuseofthisasset,anadjustingentryismadetoallocateaportionoftheasset'scostfrom
thebalancesheettotheincomestatementasanexpense.Thisadjustingentryisrecordedby
debitingtheappropriateexpenseaccount(forexample,SuppliesExpenseorInsuranceExpense)
andcreditingtherelatedassetaccount(forexample,SuppliesorUnexpiredInsurance).
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2. Convertingliabilitiestorevenue.Abusinessmaycollectcashinadvanceforservicestobe
renderedinfutureaccountingperiods.Transactionsofthisnatureareusuallyrecordedbydebiting
Cashandbycreditingaliabilityaccount(typicallycalledUnearnedRevenueorCustomer
Deposits).Here,theliabilityaccountcreatedrepresentsthedeferral(orthepostponement)ofa
revenue.Intheperiodthatservicesareactuallyrendered(orthatgoodsaresold),anadjusting
entryismadetoallocateaportionoftheliabilityfromthebalancesheettotheincomestatementto
recognizetherevenueearnedduringtheperiod.Theadjustingentryisrecordedbydebitingthe
liability(UnearnedRevenueorCustomerDeposits)andbycreditingRevenueEarned(orasimilar
account)forthevalueoftheservices.
3. Accruingunpaidexpenses.Anexpensemaybeincurredinthecurrentaccountingperiodeven
thoughnocashpaymentwilloccuruntilafutureperiod.Theseaccruedexpensesarerecordedby
anadjustingentrymadeattheendofeachaccountingperiod.Theadjustingentryisrecordedby
debitingtheappropriateexpenseaccount(forexample,InterestExpenseorSalaryExpense)andby
creditingtherelatedliability(forexample,InterestPayableorSalariesPayable).
4. Accruinguncollectedrevenue.Revenuemaybeearned(oraccrued)duringthecurrentperiod,
eventhoughthecollectionofcashwillnotoccuruntilafutureperiod.Unrecordedearnedrevenue,
forwhichnocashhasbeenreceived,requiresanadjustingentryattheendoftheaccounting
period.Theadjustingentryisrecordedbydebitingtheappropriateasset(forexample,Accounts
ReceivableorInterestReceivable)andbycreditingtheappropriaterevenueaccount(forexample,
ServiceRevenueEarnedorInterestEarned).
ADJUSTINGENTRIESANDTIMINGDIFFERENCES
Inanaccrualaccountingsystem,thereareoftentimingdifferencesbetweencashflowsandthe
recognitionofexpensesorrevenue.Acompanycanpaycashinadvanceofincurringcertainexpensesor
receivecashbeforerevenuehasbeenearned.Likewise,itcanincurcertainexpensesbeforepayingany
cashoritcanearnrevenuebeforeanycashisreceived.Thesetimingdifferences,andtheadjusting
entriesthatresultfromthem,aresummarizedbelow.
Adjustingentriestoconvertassetstoexpensesresultfromcashbeingpaidpriortoanexpense
beingincurred.
Adjustingentriestoconvertliabilitiestorevenueresultfromcashbeingreceivedpriortorevenue
beingearned.
Adjustingentriestoaccrueunpaidexpensesresultfromexpensesbeingincurredbeforecashis
paid.
Adjustingentriestoaccrueuncollectedrevenueresultfromrevenuebeingearnedbeforecashis
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received.
AsillustratedinExhibit41,adjustingentriesprovideimportantlinkagesbetweenaccountingperiods
relatedtothesetimingdifferences.Specifically,theylink:(1)priorperiodcashoutflowstocurrent
periodexpenses,(2)priorperiodcashinflowstocurrentperiodrevenue,(3)currentperiodexpensesto
futurecashoutflows,and(4)currentperiodrevenuetofutureperiodcashinflows.
EXHIBIT41
AdjustingEntriesProvideLinksBetweenAccountingPeriods
EXHIBIT41
AdjustingEntriesProvideLinksBetweenAccountingPeriods
CHARACTERISTICSOFADJUSTINGENTRIES
Keepinmindtwoimportantcharacteristicsofalladjustingentries:First,everyadjustingentryinvolves
therecognitionofeitherrevenueorexpenses.Revenueandexpensesrepresentchangesinowners'
equity.However,owners'equitycannotchangebyitselftherealsomustbeacorrespondingchangein
eitherassetsorliabilities.Thuseveryadjustingentryaffectsbothanincomestatementaccount(revenue
orexpense)andabalancesheetaccount(assetorliability).Rarelydoadjustingentriesincludeanentryto
Cash.Itisimportanttorecognizethatnoneoftheadjustmentsdiscussedinthischapterrequireadebitor
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acredittoCash.
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Second,adjustingentriesarebasedontheconceptsofaccrualaccounting,notuponmonthlybillsor
monthendtransactions.NoonesendsOvernightAutoServiceabillsaying,ShopSupplyExpensefor
themonthis$500.YetOvernightmustbeawareoftheneedtorecordtheestimatedcostofshop
suppliesconsumedifitistomeasureincomeproperlyfortheperiod.Makingadjustingentriesrequiresa
greaterunderstandingofaccrualaccountingconceptsthandoestherecordingofroutinebusiness
transactions.Inmanybusinesses,theadjustingprocessisperformedbythecontrollerorbyaprofessional
accountant,ratherthanbytheregularaccountingstaff.
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YEARENDATOVERNIGHTAUTOSERVICE
Toillustratethevarioustypesofadjustingentries,wewillagainuseourexampleinvolvingOvernight
AutoService.Chapter3concludedwithOvernight'strialbalancedatedFebruary28,2015(theendofthe
company'ssecondmonthofoperations).WewillnowskipaheadtoDecember31,2015theendof
Overnight'sfirstyearofoperations.Thiswillenableustoillustratethepreparationofannualfinancial
statements,ratherthanstatementsthatcoveronlyasinglemonth.
Mostcompaniesmakeadjustingentrieseverymonth.WewillassumethatOvernighthasbeenfollowing
thisapproachthroughout2015.Thecompany'sunadjustedtrialbalancedatedDecember31,2015,
appearsinExhibit42.ItisreferredtoasanunadjustedtrialbalancebecauseOvernightlastmade
adjustingentriesonNovember30therefore,itisstillnecessarytomakeadjustingentriesforthemonth
ofDecember.
EXHIBIT42
UnadjustedTrialBalance
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d
OVERNIGHTAUTOSERVICE
TRIALBALANCE
DECEMBER31,2015
Cash............................................ $18,592
Accountsreceivable................................
6,500
Shopsupplies.....................................
1,800
Unexpiredinsurance................................
4,500
Toolsandequipment................................
12,000
Accumulateddepreciation:toolsandequipment..........
2,000
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Building..........................................
36,000
Accumulateddepreciation:building....................
Land.............................................
$1,500
52,000
Notespayable.....................................
4,000
Accountspayable..................................
2,690
Incometaxespayable...............................
1,560
Unearnedrentrevenue..............................
9,000
Capitalstock......................................
80,000
Retainedearnings..................................
Dividends.........................................
14,000
Repairservicerevenue..............................
171,250
Advertisingexpense................................
3,900
Wagesexpense....................................
56,800
Suppliesexpense..................................
6,900
Depreciationexpense:building........................
1,500
Depreciationexpense:toolsandequipment..............
2,000
Utilitiesexpense...................................
19,400
Insuranceexpense.................................
13,500
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Incometaxesexpense.............................. 22,608
$272,000 $272,000
EXHIBIT42
UnadjustedTrialBalance
Inthenextfewpagesweillustrateseveraltransactions,aswellastherelatedadjustingentries.Bothare
shownintheformatofgeneraljournalentries.Tohelpdistinguishbetweentransactionsandadjusting
entries,transactionsareprintedinblueandadjustingentriesinred.
CONVERTINGASSETSTOEXPENSES
LO43
LO43
LEARNINGOBJECTIVE
Prepareadjustingentriestoconvertassetstoexpenses.
Whenabusinessmakesanexpenditurethatwillbenefitmorethanoneaccountingperiod,theamount
usuallyisdebitedtoanassetaccount.Attheendofeachperiodbenefitingfromthisexpenditure,an
adjustingentryismadetotransferanappropriateportionofthecostfromtheassetaccounttoanexpense
account.Thisadjustingentryreflectsthefactthatpartoftheassethasbeenuseduporbecomean
expenseduringthecurrentaccountingperiod.
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Anadjustingentrytoconvertanassettoanexpenseconsistsofadebittoanexpenseaccountandacredit
toanassetaccount(orcontraassetaccount).Examplesoftheseadjustmentsincludetheentriesto
apportionthecostsofprepaidexpensesandentriestorecorddepreciationexpense.
PrepaidExpenses
PrepaidExpensesPaymentsinadvanceoftenaremadeforsuchitemsasinsurance,rent,andoffice
supplies.Iftheadvancepayment(orprepayment)willbenefitmorethanjustthecurrentaccounting
period,thecostrepresentsanassetratherthananexpense.Thecostofthisassetwillbeallocatedto
expenseintheaccountingperiodsinwhichtheservicesorthesuppliesareused.Insummary,prepaid
expensesareassetstheybecomeexpensesonlyasthegoodsorservicesareusedup.
ShopSupplies
ShopSuppliesToillustrate,considerOvernight'saccountingpoliciesforshopsupplies.Assuppliesare
purchased,theircostisdebitedtotheassetaccountShopSupplies.Itisnotpracticaltomakejournal
entrieseveryfewminutesassuppliesareused.Instead,anestimateismadeofthesuppliesremainingon
handattheendofeachmonththesuppliesthataremissingareassumedtohavebeenused.
PriortomakingadjustingentriesatDecember31,thebalanceinOvernight'sShopSuppliesaccountis
$1,800.ThebalanceofthisassetaccountrepresentsshopsuppliesonhandonNovember30.The
SuppliesExpenseaccountshowsabalanceof$6,900,whichrepresentsthecostofsuppliesusedthrough
November30.Assumethatapproximately$1,200ofshopsuppliesremainonhandatDecember31.This
suggeststhatsuppliescostingabout$600havebeenusedinDecemberthus,thefollowingadjusting
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entryismade:
Theadjustingentryrequiredtoconvertthecostofsuppliesusedfromanassetaccounttoan
expense
d
Dec.31SuppliesExpense..................................... 600
ShopSupplies....................................
600
DecemberShopSuppliesadjustingentry.
Thisadjustingentryservestwopurposes:(1)Itchargestoexpensethecostofsuppliesusedin
December,and(2)itreducesthebalanceoftheShopSuppliesaccountto$1,200theamountof
suppliesestimatedtobeonhandatDecember31.
InsurancePolicies
InsurancePoliciesInsurancepoliciesalsoareaprepaidexpense.Thesepoliciesprovideabenefit,
insuranceprotection,overaspecificperiodoftime.Asthetimepasses,theinsurancepolicyexpires
thatis,itisusedupinbusinessoperations.
Toillustrate,assumethatonMarch1,Overnightpurchasedfor$18,000aoneyearinsurancepolicy
providingcomprehensiveliabilityinsuranceandinsuranceagainstfireanddamagetocustomers'vehicles
whileinOvernight'sfacilities.Thisexpenditure(atransaction)wasdebitedtoanassetaccount,as
follows(again,thisisatransaction,notanadjustingentry):
Purchase12monthsofinsurancecoverage
d
Mar.1UnexpiredInsurance.................................
18,000
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Cash..........................................
18,000
Purchasedaninsurancepolicyprovidingcoverageforthenext12months.
This$18,000expenditureprovidesinsurancecoverageforaperiodofonefullyear.Therefore,1/12of
thiscost,or$1,500,isrecognizedasinsuranceexpenseeverymonth.The$13,500insuranceexpense
reportedinOvernight'strialbalancerepresentstheportionoftheinsurancepolicythathasexpired
betweenMarch1andNovember30($1,500/mo.9months).The$4,500amountofunexpiredinsurance
showninthetrialbalanceistheremainingcostofthe12monthpolicystillineffectasofNovember30
($1,500/mo.3months).ByDecember31,anotherfullmonthofthepolicyhasexpired.Thus,the
insuranceexpenseforDecemberisrecordedbythefollowingadjustingentryatmonthend:
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TheadjustingentryrequiredtorecordthecostofinsurancecoverageexpiringinDecember
d
Dec.31InsuranceExpense.................................... 1,500
UnexpiredInsurance...............................
1,500
DecemberInsuranceExpenseadjustingentry.
Noticethesimilaritiesbetweentheeffectsofthisadjustingentryandtheonethatwemadepreviouslyfor
shopsupplies.Inbothcases,theentriestransfertoexpensethatportionofanassetusedupduringthe
period.ThisflowofcostsfromthebalancesheettotheincomestatementisillustratedinExhibit43.
EXHIBIT43
AnExpiredAssetBecomesAnExpense
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EXHIBIT43
AnExpiredAssetBecomesAnExpense
YOURTURNYouasaCarOwner
Carownerstypicallypayinsurancepremiumssixmonthsinadvance.Assumethatyourecentlypaidyour
sixmonthpremiumof$600onFebruary1(forcoveragethroughJuly31).OnMarch31,youdecideto
switchinsurancecompanies.Youcallyourexistingagentandaskthatyourpolicybecanceled.Areyou
entitledtoarefund?Ifso,why,andhowmuchwillitbe?
(SeeourcommentsontheOnlineLearningCenterwebsite.)
RecordingPrepaymentsDirectlyintheExpenseAccounts
RecordingPrepaymentsDirectlyintheExpenseAccountsInourillustration,paymentsforshop
suppliesandforinsurancecoveringmorethanoneperiodweredebitedtoassetaccounts.However,some
companiesfollowanalternativepolicyofdebitingsuchprepaymentsdirectlytoanexpenseaccount,such
asSuppliesExpense.Attheendoftheperiod,theadjustingentrythenwouldbetodebitShopSupplies
andcreditSuppliesExpenseforthecostofsuppliesthathadnotbeenused.
ThisalternativemethodleadstothesameresultsasdoestheprocedureusedbyOvernight.Undereither
approach,thecostofsuppliesusedduringthecurrentperiodistreatedasanexpense,andthecostof
suppliesstillonhandiscarriedforwardinthebalancesheetasanasset.
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Inthistext,wewillfollowOvernight'spracticeofrecordingprepaymentsinassetaccountsandthen
makingadjustmentstotransferthesecoststoexpenseaccountsastheassetsexpire.Thisapproach
correctlydescribestheconceptualflowofcoststhroughtheelementsoffinancialstatements.Thatis,a
prepaymentisanassetthatlaterbecomesanexpense.Thealternativeapproachisusedwidelyinpractice
onlybecauseitisanefficientshortcut,whichstandardizestherecordingoftransactionsandmay
reducethenumberofadjustingentriesneededattheendoftheperiod.Remember,ourgoalinthiscourse
istodevelopyourabilitytounderstandanduseaccountinginformation,nottotrainyouinalternative
bookkeepingprocedures.
Theideaofshopsuppliesandinsurancepoliciesbeingusedupoverseveralmonthsiseasyto
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understand.Butthesameconceptalsoappliestoassetssuchasbuildingsandequipment.Theseassetsare
convertedtoexpensesthroughtheprocessofdepreciation.
THECONCEPTOFDEPRECIATION
Depreciableassetsarephysicalobjectsthatretaintheirsizeandshapebutthateventuallywearoutor
becomeobsolete.Theyarenotphysicallyconsumed,asareassetssuchassupplies,butnonethelesstheir
economicusefulnessdiminishesovertime.Examplesofdepreciableassetsincludebuildingsandall
typesofequipment,fixtures,furnishingsandevenrailroadtracks.Land,however,isnotviewedasa
depreciableasset,asithasanunlimitedusefullife.
Eachperiod,aportionofadepreciableasset'susefulnessexpires.Therefore,acorrespondingportionof
itscostisrecognizedasdepreciationexpense.
WhatIsDepreciation?
WhatIsDepreciation?Inaccounting,thetermdepreciationmeansthesystematicallocationofthecost
ofadepreciableassettoexpenseovertheasset'susefullife.ThisprocessisillustratedinExhibit44.
NoticethesimilaritiesbetweenExhibit44andExhibit43.
EXHIBIT44
TheDepreciationProcess
EXHIBIT44
TheDepreciationProcess
Depreciationisnotanattempttorecordchangesintheasset'smarketvalue.Intheshortrun,themarket
valueofsomedepreciableassetsmayevenincrease,buttheprocessofdepreciationcontinuesanyway.
Therationalefordepreciationliesinthematchingprinciple.Ourgoalistooffsetareasonableportionof
theasset'scostagainstrevenueineachperiodoftheasset'susefullife.
Depreciationexpenseoccurscontinuouslyoverthelifeoftheasset,buttherearenodailydepreciation
transactions.Ineffect,depreciationexpenseispaidinadvancewhentheassetisoriginallypurchased.
Therefore,adjustingentriesareneededattheendofeachaccountingperiodtotransferanappropriate
amountoftheasset'scosttodepreciationexpense.
DepreciationIsOnlyanEstimate
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DepreciationIsOnlyanEstimateTheappropriateamountofdepreciationexpenseisonlyanestimate.
Afterall,wecannotlookatabuildingorapieceofequipmentanddeterminepreciselyhowmuchofits
economicusefulnesshasexpiredduringthecurrentperiod.
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Themostwidelyusedmeansofestimatingperiodicdepreciationexpenseisthestraightlinemethodof
depreciation.Underthestraightlineapproach,anequalportionoftheasset'scostisallocatedto
depreciationexpenseineveryperiodoftheasset'sestimatedusefullife.Theformulaforcomputing
depreciationexpensebythestraightlinemethodis:2
Theuseofanestimatedusefullifeisthemajorreasonthatdepreciationexpenseisonlyanestimate.In
mostcases,managementdoesnotknowinadvanceexactlyhowlongtheassetwillremaininuse.
CASEINPOINT
DigitalVision/Alamy
DigitalVision/Alamy
Howlongdoesabuildinglast?Forpurposesofcomputingdepreciationexpense,mostcompanies
estimateabout30or40years.YettheEmpireStateBuildingwasbuiltin1931,andit'snotlikelytobe
torndownanytimesoon.Asyoumightguess,itoftenisdifficulttoestimateinadvancejusthowlong
depreciableassetsmayremaininuse.
DepreciationofOvernight'sBuilding
DepreciationofOvernight'sBuildingOvernightpurchaseditsbuildingfor$36,000onJanuary22.
Becausethebuildingwasold,itsestimatedremainingusefullifeisonly20years.Therefore,the
building'smonthlydepreciationexpenseis$150($36,000cost240months).Wewillassumethat
OvernightdidnotrecordanydepreciationexpenseinJanuarybecauseitoperatedforonlyasmallpartof
themonth.Thus,thebuilding's$1,500depreciationexpensereportedinOvernight'strialbalance
illustratedinExhibit42onpage145represents10fullmonthsofdepreciationrecordedin2015,from
February1throughNovember30($150/mo.10months).Anadditional$150ofdepreciationexpenseis
stillneededonthebuildingforDecember(bringingthetotaltobereportedintheincomestatementfor
theyearto$1,650).
TheadjustingentrytorecorddepreciationexpenseonOvernight'sbuildingforthemonthofDecember
is:
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d
Dec.31DepreciationExpense:Building............................. 150
AccumulatedDepreciation:Building......................
150
Decemberbuildingdepreciationadjustingentry($36,000240mo.).
Theadjustingentryrequiredtorecordmonthlydepreciationonthebuilding
TheDepreciationExpense:BuildingaccountwillappearinOvernight'sincomestatementalongwith
otherexpensesfortheyearendedDecember31,2015.ThebalanceintheAccumulatedDepreciation:
BuildingaccountwillbereportedintheDecember31balancesheetasadeductionfromtheBuilding
Account,asshownbelow.
Building.................................................. $36,000
Less:AccumulatedDepreciation:Building....................... (1,650)
BookValue............................................... $34,350
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Howaccumulateddepreciationappearsinthebalancesheet
AccumulatedDepreciation:Buildingisanexampleofacontraassetaccountbecause(1)ithasacredit
balance,and(2)itisoffsetagainstanassetaccount(Building)toproducethebookvaluefortheasset.
Accountantsoftenusethetermbookvalue(orcarryingvalue)todescribethenetvaluationofanassetin
acompany'saccountingrecords.Fordepreciableassets,suchasbuildingsandequipment,bookvalueis
equaltothecostoftheasset,lesstherelatedamountofaccumulateddepreciation.Theendresultof
creditingtheAccumulatedDepreciation:Buildingaccountismuchthesameasifthecredithadbeen
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madedirectlytotheBuildingaccountthatis,thebookvaluereportedinthebalancesheetforthe
buildingisreducedfrom$36,000to$34,350.
Bookvalueisofsignificanceprimarilyforaccountingpurposes.Itrepresentscoststhatwillbeoffset
againsttherevenueoffutureperiods.Italsogivesusersoffinancialstatementsanindicationoftheageof
acompany'sdepreciableassets(olderassetstendtohavelargeramountsofaccumulateddepreciation
associatedwiththemthannewerassets).Itisimportanttorealizethatthecomputationofbookvalueis
baseduponanasset'shistoricalcost.Thus,bookvalueisnotintendedtorepresentanasset'scurrent
marketvalue.
DepreciationofToolsandEquipment
DepreciationofToolsandEquipmentOvernightdepreciatesitstoolsandequipmentoveraperiodof
fiveyears(60months)usingthestraightlinemethod.TheDecember31trialbalanceshowsthatthe
companyownstoolsandequipmentthatcost$12,000.Therefore,theadjustingentrytorecord
December'sdepreciationexpenseis:
Theadjustingentryrequiredtorecordthemonthlydepreciationontoolsandequipment
d
Dec.31DepreciationExpense:ToolsandEquipment................
AccumulatedDepreciation:ToolsandEquipment.........
200
200
Decembertoolsandequipmentadjustingentry($12,00060months=$200/mo.).
Again,weassumethatOvernightdidnotrecorddepreciationexpensefortoolsandequipmentinJanuary
becauseitoperatedforonlyasmallpartofthemonth.Thus,therelated$2,000depreciationexpense
reportedinOvernight'strialbalanceinExhibit42onpage145represents10fullmonthsofdepreciation,
fromFebruary1throughNovember30($200/mo.10months).Thetoolsandequipmentstillrequirean
additional$200ofdepreciationforDecember(bringingthetotaltobereportedintheincomestatement
fortheyearto$2,200).
WhatisthebookvalueofOvernight'stoolsandequipmentatDecember31,2015?Ifyousaid$9,800,
you'reright.3
DepreciationANoncashExpense
DepreciationANoncashExpenseDepreciationisanoncashexpense.Wehavemadethepointthatnet
incomedoesnotrepresentaninflowofcashoranyotherasset.Rather,itisacomputationoftheoverall
effectofcertainbusinesstransactionsonowners'equity.Therecognitionofdepreciationexpense
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illustratesthispoint.Asdepreciableassetsexpire,depreciationexpenseisrecorded,netincomeis
reduced,andowners'equitydeclines,butthereisnocorrespondingcashoutlayinthecurrentperiod.For
thisreason,depreciationiscalledanoncashexpense.Oftenitrepresentsthelargestdifferencebetween
netincomeandthecashflowfrombusinessoperations.
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CONVERTINGLIABILITIESTOREVENUE
LO44
LO44
LEARNINGOBJECTIVE
Prepareadjustingentriestoconvertliabilitiestorevenue.
Insomeinstances,customersmaypayinadvanceforservicestoberenderedinlateraccountingperiods.
Forexample,afootballteamcollectsmuchofitsrevenueinadvancethroughthesaleofseasontickets.
Healthclubscollectinadvancebysellinglongtermmembershipcontracts.Airlinessellmanyoftheir
ticketswellinadvanceofscheduledflights.
Foraccountingpurposes,amountscollectedinadvancedonotrepresentrevenue,becausetheseamounts
havenotyetbeenearned.Amountscollectedfromcustomersinadvancearerecordedbydebitingthe
Cashaccountandcreditinganunearnedrevenueaccount.Unearnedrevenuesometimesisreferredtoas
deferredrevenue.
Whenacompanycollectsmoneyinadvancefromitscustomers,ithasanobligationtorenderservicesin
thefuture.Therefore,thebalanceofanunearnedrevenueaccountisconsideredtobealiabilityit
appearsintheliabilitysectionofthebalancesheet,notintheincomestatement.Unearnedrevenue
differsfromotherliabilitiesbecauseitusuallywillbesettledbyrenderingservices,ratherthanby
makingpaymentincash.Inshort,itwillbeworkedoffratherthanpaidoff.Ofcourse,ifthebusinessis
unabletorendertheservice,itmustdischargethisliabilitybyrefundingmoneytoitscustomers.
Whenacompanyrenderstheservicesforwhichcustomershavepaidinadvance,itisworkingoffits
liabilitytothesecustomersandisearningtherevenue.Attheendoftheaccountingperiod,anadjusting
entryismadetotransferanappropriateamountfromtheunearnedrevenueaccounttoarevenueaccount.
Thisadjustingentryconsistsofadebittoaliabilityaccount(unearnedrevenue)andacredittoarevenue
account.Forinstance,TheNewYorkTimesCompanyreportsa$67millioncurrentliabilityinits
balancesheetcalledUnexpiredSubscriptions.Thisaccountrepresentsunearnedrevenuefromselling
subscriptionsforfuturenewspaperdeliveries.TheliabilityisconvertedtoCirculationRevenueand
reportedinthecompany'sincomestatementastheactualdeliveriesoccur.
Toillustratetheseconcepts,assumethatonDecember1,HarborCabCo.agreedtorentspacein
Overnight'sbuildingtoprovideindoorstorageforsomeofitscabs.Theagreeduponrentis$3,000per
month,andHarborCabpaidforthefirstthreemonthsinadvance.Thejournalentrytorecordthis
transactiononDecember1was(again,thisisatransaction,notanadjustingentry):
d
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Dec.1Cash............................................
9,000
UnearnedRentRevenue.........................
9,000
CollectedinadvancefromHarborCabforrentalofstoragespaceforthreemonths.
Anadvanceit'snotrevenueit'saliability
RememberthatUnearnedRentRevenueisaliabilityaccount,notarevenueaccount.Overnightwillearn
rentalrevenuegraduallyoverathreemonthperiodasitprovidesstoragefacilitiesforHarborCab.Atthe
endofeachofthesethreemonths,Overnightwillmakeanadjustingentry,transferring$3,000fromthe
UnearnedRentRevenueaccounttoanearnedrevenueaccount,RentRevenueEarned,whichwillappear
inOvernight'sincomestatement.ThefirstinthisseriesofmonthlytransferswillbemadeatDecember
31withthefollowingadjustingentry:
d
Dec. UnearnedRentRevenue.............................
31
RentRevenueEarned...........................
3,000
3,000
DecemberadjustingentrytoconvertUnearnedRentRevenuetoRentRevenueEarned
($9,0003mo.).
AnadjustingentryshowingthatsomeunearnedrevenuewasearnedinDecember
Afterthisadjustingentryhasbeenposted,theUnearnedRentRevenueaccountwillhavea$6,000credit
balance.ThisbalancerepresentsOvernight'sobligationtorender$6,000worthofserviceoverthenext
twomonthsandwillappearintheliabilitysectionofthecompany'sbalancesheet.TheRentRevenue
EarnedaccountwillappearinOvernight'sincomestatement.
TheconversionofunearnedrevenuetorecognizeearnedrevenueisillustratedinExhibit45.
Page152
EXHIBIT45
UnearnedRevenueBecomesEarnedRevenue
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EXHIBIT45
UnearnedRevenueBecomesEarnedRevenue
RecordingAdvanceCollectionsDirectlyintheRevenueAccounts
RecordingAdvanceCollectionsDirectlyintheRevenueAccountsWehavestressedthatamounts
collectedfromcustomersinadvancerepresentliabilities,notrevenue.However,somecompaniesfollow
anaccountingpolicyofcreditingtheseadvancecollectionsdirectlytorevenueaccounts.Theadjusting
entrythenshouldconsistofadebittotherevenueaccountandacredittotheunearnedrevenueaccount
fortheportionoftheadvancepaymentsnotyetearned.Thisalternativeaccountingpracticeleadstothe
sameresultsasdoesthemethodusedinourillustration.
Inthistext,wewillfollowtheoriginallydescribedpracticeofcreditingadvancepaymentsfrom
customerstoanunearnedrevenueaccount.
ACCRUINGUNPAIDEXPENSES
LO45
LO45
LEARNINGOBJECTIVE
Prepareadjustingentriestoaccrueunpaidexpenses.
Thistypeofadjustingentryrecognizesexpensesthatwillbepaidinfuturetransactionstherefore,no
costhasyetbeenrecordedintheaccountingrecords.Salariesofemployeesandinterestonborrowed
moneyarecommonexamplesofexpensesthataccumulatefromdaytodaybutthatusuallyarenot
recordeduntiltheyarepaid.Theseexpensesaresaidtoaccrueovertime,thatis,togroworto
accumulate.Attheendoftheaccountingperiod,anadjustingentryshouldbemadetorecordany
expensesthathaveaccruedbutthathavenotyetbeenrecorded.Sincetheseexpenseswillbepaidata
futuredate,theadjustingentryconsistsofadebittoanexpenseaccountandacredittoaliability
account.WeshallnowusetheexampleofOvernightAutoServicetoillustratethistypeofadjusting
entry.
AccrualofWages(orSalaries)Expense
AccrualofWages(orSalaries)ExpenseOvernight,likemanybusinesses,paysitsemployeesevery
otherFriday.Thismonth,however,endsonaTuesdaythreedaysbeforethenextscheduledpayday.
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ThusOvernight'semployeeshaveworkedformorethanaweekinDecemberforwhichtheyhavenotyet
beenpaid.
Timecardsindicatethatsincethelastpayrolldate,Overnight'semployeeshaveworkedatotalof130
hours.Includingpayrolltaxes,Overnight'swageexpenseaveragesabout$15perhour.Therefore,at
December31,thecompanyowesitsemployeesapproximately$1,950forworkperformedinDecember.4
Thefollowingadjustingentryshouldbemadetorecordthisamountbothaswagesexpenseofthecurrent
periodandasaliability:
Adjustingentryrequiredtoaccruewagesowedattheendofthemonth
d
Dec.31WagesExpense......................................
WagesPayable...................................
1,950
1,950
AdjustingentrytoaccruewagesowedbutunpaidasofDecember31.
Page153
ThisadjustingentryincreasesOvernight'swagesexpensefor2015andalsocreatesaliabilitywages
payablethatwillappearintheDecember31balancesheet.
OnFriday,January3,2016,Overnightwillpayitsregularbiweeklypayroll.Letusassumethatthis
payrollamountsto$2,397.Inthiscase,thetransactiontorecordpaymentisasfollows(again,thisisa
transaction,notanadjustingentry):5
Paymentofwagesearnedintwoaccountingperiods
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2016
Jan.3WagesExpense(forJanuary)...........................
447
WagesPayable(accruedinDecember)...................
1,950
Cash...........................................
2,397
Biweeklypayroll,$1,950ofwhichhadbeenaccruedatDecember31,2015.
AccrualofInterestExpense
AccrualofInterestExpenseOnJanuary22,2015,Overnightpurchaseditsbuilding,anoldbusgarage,
fromtheMetropolitanTransitAuthorityfor$36,000.Overnightpaid$6,000cash,andissueda$30,000
90daynotepayableforthebalanceowed.Overnightpaidthe$30,000obligationinApril.Therewasno
interestexpensetoaccruebecausethisnotepayablewasnoninterestbearing.
OnNovember30,2015,Overnightborrowed$4,000fromAmericanNationalBankbyissuingan
interestbearingnotepayable.Thisloanistoberepaidinthreemonths(onFebruary28,2016),along
withinterestcomputedatanannualrateof9percent.TheentrymadeonNovember30torecordthis
borrowingtransactionis(again,thisisatransaction,notanadjustingentry):
d
Nov. Cash............................................
30
NotesPayable................................
4,000
4,000
BorrowedcashfromAmericanNationalBank,issuinga9%,$4,000notepayable,due
inthreemonths.
OnFebruary28,Overnightmustpaythebank$4,090.Thisrepresentsthe$4,000amountborrowed,plus
$90interest($4,000.093/12).The$90interestchargecoversaperiodofthreemonths.Althoughno
paymentismadeuntilFebruary28,2016,interestexpenseisincurred(oraccrued)atarateof$30per
month,asshowninExhibit46.
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EXHIBIT46
AccrualofInterest
EXHIBIT46
AccrualofInterest
ThefollowingadjustingentryismadeatDecember31toaccrueonemonth'sinterestexpenseandto
recordtheamountofunpaidinterestowedtothebankatDecember31,2015:
AdjustingentryrequiredtorecordinterestexpenseaccruedinDecember
d
Dec.31InterestExpense...........................................
InterestPayable.......................................
30
30
AdjustingentrytoaccrueDecemberInterestExpense($4,000.091/12).
Page154
The$30interestexpensethataccruedinDecemberwillappearinOvernight's2015incomestatement.
Boththe$30interestpayableandthe$4,000notepayabletoAmericanNationalBankwillappearas
liabilitiesintheDecember31,2015,balancesheet.
Overnightwillmakeasecondadjustingentryrecognizinganother$30ininterestexpenseonJanuary31,
2016.ThetransactiononFebruary28torecordtherepaymentofthisloan,including$90ininterest
charges,is(again,thisisatransaction,notanadjustingentry):
Paymentofinterestexpenseaccruedoverthreemonths
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d
2016
Feb.
28
NotesPayable.........................................
4,000
InterestPayable(fromDecemberandJanuary)...............
60
InterestExpense(Februaryonly)...........................
30
Cash.............................................
4,090
Repaid$4,000notepayabletoAmericanNationalBank,including$90ininterest
charges.
ACCRUINGUNCOLLECTEDREVENUE
LO46
LO46
LEARNINGOBJECTIVE
Prepareadjustingentriestoaccrueuncollectedrevenue.
Abusinessmayearnrevenueduringthecurrentaccountingperiodbutnotbillthecustomeruntilafuture
accountingperiod.Thissituationislikelytooccurifadditionalservicesarebeingperformedforthesame
customer,inwhichcasethebillmightnotbeprepareduntilallservicesarecompleted.Anyrevenuethat
hasbeenearnedbutnotrecordedduringthecurrentaccountingperiodshouldberecordedattheendof
theperiodbymeansofanadjustingentry.Thisadjustingentryconsistsofadebittoanaccount
receivableandacredittotheappropriaterevenueaccount.Thetermaccruedrevenueoftenisusedto
describerevenuethathasbeenearnedduringtheperiodbutthathasnotbeenrecordedpriortothe
closingdate.
Toillustratethistypeofadjustingentry,assumethatinDecember,Overnightenteredintoanagreement
toperformroutinemaintenanceonseveralvansownedbyAirportShuttleService.Overnightagreedto
maintainthesevansforaflatfeeof$1,500permonth,payableonthefifteenthofeachmonth.
Noentrywasmadetorecordthesigningofthisagreement,becausenoserviceshadyetbeenrendered.
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OvernightbeganrenderingservicesonDecember15,butthefirstmonthlypaymentwillnotbereceived
untilJanuary15.Therefore,OvernightshouldmakethefollowingadjustingentryatDecember31to
recordtherevenueearnedfromAirportShuttleduringthemonth:
Adjustingentryrequiredtoaccruerevenueearnedbutnotyetbilledorcollected
d
Dec.31AccountsReceivable...................................
RepairServiceRevenue.............................
750
750
AdjustingentrytorecordaccruedRepairServiceRevenueearnedinDecember.
ThecollectionofthefirstmonthlyfeefromAirportShuttlewilloccuronJanuary15,2016.Ofthis
$1,500cashreceipt,halfrepresentscollectionofthereceivablerecordedonDecember31theotherhalf
representsrevenueearnedinJanuary.Thus,thetransactiontorecordthereceiptof$1,500fromAirport
ShuttleonJanuary15willbe(again,thisisatransaction,notanadjustingentry):
Entrytorecordcollectionofaccruedrevenue
d
2016
Jan. Cash.............................................
15
AccountsReceivable.............................
1,500
750
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RepairServiceRevenue...........................
750
CashcollectedfromAirportShuttleforvanmaintenanceprovidedDecember15through
January15.
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ThenetresultoftheDecember31adjustingentryhasbeentodividetherevenuefrommaintenanceof
AirportShuttle'svansbetweenDecemberandJanuaryinproportiontotheservicesrenderedduringeach
month.
ACCRUINGINCOMETAXESEXPENSE:THEFINALADJUSTINGENTRY
Asacorporationearnstaxableincome,itincursincometaxesexpense,andalsoaliabilityto
governmentaltaxauthorities.Thisliabilityispaidinfourinstallmentscalledestimatedquarterly
payments.ThefirstthreepaymentsnormallyaremadeonApril15,June15,andSeptember15.Thefinal
installmentactuallyisdueonDecember15butforpurposesofourillustrationandassignmentmaterials,
wewillassumethefinalpaymentisnotdueuntilJanuary15ofthefollowingyear.6
Initsunadjustedtrialbalance(Exhibit42onpage145),Overnightshowsincometaxesexpenseof
$22,608.ThisistheincometaxesexpenserecognizedfromJanuary20,2015,(thedateOvernightopened
forbusiness)throughNovember30,2015.IncometaxesaccruedthroughSeptember30havealready
beenpaid.Thus,the$1,560liabilityforincometaxespayablerepresentsonlytheincometaxesaccrued
inOctoberandNovember.
Theamountofincometaxesexpenseaccruedforanygivenmonthisonlyanestimate.Theactualamount
ofincometaxescannotbedetermineduntilthecompanypreparesitsannualincometaxreturn.Inour
illustrationsandassignmentmaterials,weestimateincometaxesexpenseat40percentoftaxable
income.Wealsoassumethattaxableincomeisequaltoincomebeforeincometaxes,asubtotaloften
showninanincomestatement.Thissubtotalistotalrevenuelessallexpensesotherthanincometaxes.
INTERNATIONALCASEINPOINT
Corporateincometaxratesvaryaroundtheworld.Arecentsurveyshowsthatratesrangefrom9percent
inMontenegroto55percentintheUnitedArabEmirates.Worldwide,theaveragetaxrateis24percent.
TheaveragerateintheUnitedStatesis40percent.*Inadditiontocorporateincometaxes,some
countriesalso(1)withholdtaxesondividends,interest,androyalties,(2)chargevalueaddedtaxesat
specifiedproductionanddistributionpoints,and(3)imposebordertaxessuchascustomsandimport
duties.Afewcountries,includingtheBahanashavenocorporatetaxes.
*KPMGCorporateTaxRateSurvey(2013).
In2015,Overnightearnedincomebeforeincometaxesof$66,570(seetheincomestatementinExhibit
52,page196,inChapter5).Therefore,incometaxesexpensefortheentireyearisestimatedat$26,628
($66,57040percent).GiventhatincometaxesexpenserecognizedthroughNovember30amountsto
$22,608(seetheunadjustedtrialbalanceinExhibit42),anadditional$4,020inincometaxesexpense
musthaveaccruedduringDecember($26,628$22,608).Theadjustingentrytorecordthisexpenseis:
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AdjustingentryrequiredtorecordincometaxesaccruedinDecember
d
Dec.31IncomeTaxesExpense............................... 4,020
IncomeTaxesPayable............................
4,020
AdjustingentrytorecordincometaxesaccruedinDecember.
Page156
ThisentryincreasesthebalanceintheIncomeTaxesExpenseaccounttothe$26,628amountrequired
fortheyearendedDecember31,2015.Italsoincreasestheliabilityforincometaxespayableto$5,580
($1,560+$4,020).ThetransactiontorecordthepaymentofthisliabilityonJanuary15,2016,willbe
(again,thisisatransaction,notanadjustingentry):
d
2016
Jan.15IncomeTaxesPayable...........................5,580
Cash.....................................
5,580
Paymentoftheremaining2015incometaxliability.
IncomeTaxesinUnprofitablePeriods
IncomeTaxesinUnprofitablePeriodsWhathappenstoincometaxesexpensewhenlossesareincurred?
Inthesesituations,thecompanyrecognizesanegativeamountofincometaxesexpense.Theadjusting
entrytorecordincometaxesattheendofanunprofitableaccountingperiodconsistsofadebittoIncome
TaxesPayableandacredittoIncomeTaxesExpense.
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Negativeincometaxesexpensemeansthatthecompanymaybeabletorecoverfromthegovernment
someoftheincometaxesrecognizedasexpenseinpriorperiods.7IftheIncomeTaxesPayableaccount
hasadebitbalanceatyearend,itisreclassifiedasanasset,calledIncomeTaxRefundReceivable.A
creditbalanceintheIncomeTaxesExpenseaccountisoffsetagainsttheamountofthebeforetaxloss,as
showninExhibit47.
EXHIBIT47
PartialIncomeStatement
d
PartialIncomeStatementforanUnprofitablePeriod
Income(loss)beforeincometaxes.................................... $(20,000)
Incometaxbenefit(recoveryofpreviouslyrecordedtaxes)................. 8,000
Netloss......................................................... $(12,000)
EXHIBIT47
PartialIncomeStatement
Incometaxbenefitcanreduceapretaxloss
Wehavealreadyseenthatincometaxesexpensereducestheamountofbeforetaxprofits.Noticenow
thatincometaxbenefitsintheformoftaxrefundscanreducetheamountofapretaxloss.Thus,
incometaxesreducethesizeofbothprofitsandlosses.Thedetailedreportingofprofitsandlossesinthe
incomestatementisillustratedinChapter5.
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AdjustingEntriesandAccountingPrinciples
LO47
LO47
LEARNINGOBJECTIVE
Explainhowtheprinciplesofrealizationandmatchingrelatetoadjustingentries.
Adjustingentriesarethemeansbywhichaccountantsapplytherealizationandmatchingprinciples.
Throughtheseentries,revenuesarerecognizedastheyareearned,andexpensesarerecognizedas
resourcesareusedorconsumedinproducingtherelatedrevenue.
Inmostcases,therealizationprincipleindicatesthatrevenueshouldberecognizedatthetimegoodsare
soldorservicesarerendered.Atthispointthebusinesshasessentiallycompletedtheearningprocess
andthesalesvalueofthegoodsorservicescanbemeasuredobjectively.Atanytimepriortosale,the
ultimatesalesvalueofthegoodsorservicessoldcanonlybeestimated.Afterthesale,theonlystepthat
remainsistocollectfromthecustomer,andthisisusuallyarelativelycertainevent.
Thematchingprincipleunderliessuchaccountingpracticesasdepreciatingplantassets,measuringthe
costofsuppliesused,andamortizingthecostofunexpiredinsurancepolicies.Allendoftheperiod
adjustingentriesinvolvingexpenserecognitionareapplicationsofthematchingprinciple.
Costsarematchedwithrevenueinoneoftwoways:
1. Directassociationofcostswithspecificrevenuetransactions.Theidealmethodofmatching
revenuewithexpensesistodeterminetheactualamountofexpenseassociatedwithspecific
revenuetransactions.However,thisapproachworksonlyforthosecostsandexpensesthatcanbe
directlyassociatedwithspecificrevenuetransactions.Commissionspaidtosalespeoplearean
exampleofcoststhatcanbedirectlyassociatedwiththerevenueofaspecificaccountingperiod.
Page157
2. Systematicallocationofcostsovertheusefullifeoftheexpenditure.Manyexpenditurescontribute
totheearningofrevenueforanumberofaccountingperiodsbutcannotbedirectlyassociatedwith
specificrevenuetransactions.Examplesincludethecostsofinsurancepoliciesanddepreciable
assets.Inthesecases,accountantsattempttomatchrevenueandexpensesbysystematically
allocatingthecosttoexpenseoveritsusefullife.Straightlinedepreciationisanexampleofa
systematictechniqueusedtomatchthecostofanassetwiththerelatedrevenuethatithelpstoearn
overitsusefullife.
THECONCEPTOFMATERIALITY
LO48
LO48
LEARNINGOBJECTIVE
Explaintheconceptofmateriality.
Anotherunderlyingaccountingprinciplealsoplaysamajorroleinthemakingofadjustingentriesthe
conceptofmateriality.Thetermmaterialityreferstotherelativeimportanceofanitemoranevent.An
itemisconsideredmaterialifknowledgeoftheitemmightreasonablyinfluencethedecisionsofusersof
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financialstatements.Accountantsmustbesurethatallmaterialitemsareproperlyreportedinfinancial
statements.
However,thefinancialreportingprocessshouldbecosteffectivethatis,thevalueoftheinformation
shouldexceedthecostofitspreparation.Bydefinition,theaccountingtreatmentaccordedtoimmaterial
itemsisoflittleornoconsequencetodecisionmakers.Therefore,immaterialitemsmaybehandledin
theeasiestandmostconvenientmanner.
MaterialityandAdjustingEntries
MaterialityandAdjustingEntriesTheconceptofmaterialityenablesaccountantstoshortenand
simplifytheprocessofmakingadjustingentriesinseveralways.Forexample:
1. Businessespurchasemanyassetsthathaveaverylowcostorthatwillbeconsumedquicklyin
businessoperations.Examplesincludewastebaskets,lightbulbs,andjanitorialsupplies.The
materialityconceptpermitschargingsuchpurchasesdirectlytoexpenseaccounts,ratherthanto
assetaccounts.Thistreatmentconvenientlyeliminatestheneedtoprepareadjustingentriesto
depreciatetheseitems.
2. Someexpenses,suchastelephonebillsandutilitybills,maybechargedtoexpensesasthebillsare
paid,ratherthanastheservicesareused.Technicallythistreatmentviolatesthematching
principle.However,accountingforutilitybillsonacashbasisisveryconvenient,asthemonthly
costofutilityserviceisnotevenknownuntiltheutilitybillisreceived.Underthiscashbasis
approach,theamountofutilityexpenserecordedeachmonthisactuallybasedonthepriormonth's
bill.
3. Adjustingentriestoaccrueunrecordedexpensesorunrecordedrevenuemayactuallybeignoredif
thedollaramountsareimmaterial.
MaterialityIsaMatterofProfessionalJudgment
MaterialityIsaMatterofProfessionalJudgmentWhetheraspecificitemoreventismaterialisamatter
ofprofessionaljudgment.Inmakingthesejudgments,accountantsconsiderseveralfactors.
First,whatconstitutesamaterialamountvarieswiththesizeoftheorganization.Forexample,a$1,000
expendituremaybematerialinrelationtothefinancialstatementsofasmallbusinessbutnottothe
statementsofalargecorporationsuchasGeneralElectric.8Therearenoofficialrulesastowhat
constitutesamaterialamount,butmostaccountantswouldconsideramountsoflessthan2percentor3
percentofnetincometobeimmaterial,unlesstherewereotherfactorstoconsider.Onesuchotherfactor
isthecumulativeeffectofnumerousimmaterialevents.Eachofadozenitemsmaybeimmaterialwhen
consideredbyitself.Whenviewedtogether,however,thecombinedeffectofall12itemsmaybe
material.
Page158
Finally,materialitydependsonthenatureoftheitem,aswellasitsdollaramount.Assume,forexample,
thatseveralmanagerssystematicallyhavebeenstealingmoneyfromthecompanythattheymanage.
Stockholdersprobablywouldconsiderthisfactimportantevenifthedollaramountsweresmallin
relationtothecompany'stotalresources.
YOURTURNYouasOvernightAuto'sServiceDepartmentManager
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YoujustfoundoutthatBetty,oneofthebestmechanicsthatyousuperviseforOvernightAuto,hastaken
homesmallitemsfromthecompany'ssupplies,suchasascrewdriverandacoupleofcansofoil.When
youtalktoBetty,shesuggeststhattheseitemsareimmaterialtoOvernightAutobecausetheyarenot
recordedintheinventoryandtheyareexpensedwhentheyarepurchased.Howshouldyourespondto
Betty?
(SeeourcommentsontheOnlineLearningCenterwebsite.)
Notetostudents:Intheassignmentmaterialaccompanyingthistextbook,youaretoconsideralldollar
amountstobematerial,unlesstheproblemspecificallyraisesthequestionofmateriality.
EFFECTSOFTHEADJUSTINGENTRIES
Onpages142and143,weidentifiedfourtypesofadjustingentries,eachofwhichinvolveoneincome
statementaccountandonebalancesheetaccount.Theeffectsoftheseadjustmenttypesontheincome
statementandbalancesheetaresummarizedinEXHIBIT48.
EXHIBIT48
TheEffectsofAdjustingEntriesonTheFinancialStatements
d
IncomeStatement
BalanceSheet
Adjustment
RevenueExpensesNetIncome Assets LiabilitiesOwners'Equity
TypeI
NoeffectIncrease Decrease
DecreaseNoeffect Decrease
ConvertingAssetstoExpenses
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Increase Noeffect Increase
NoeffectDecrease Increase
ConvertingLiabilitiestoRevenue
TypeIII
AccruingUnpaidExpenses
TypeIV
AccruingUncollectedRevenue
EXHIBIT48
TheEffectsofAdjustingEntriesonTheFinancialStatements
Thefouradjustmenttypeswereillustratedanddiscussedinnineseparateadjustingentriesmadeby
OvernightonDecember31.Theseadjustmentsappearintheformatofgeneraljournalentriesin
EXHIBIT49.(OvernightalsorecordedmanytransactionsthroughoutthemonthofDecember.These
transactionsarenotillustratedherebutwereaccountedforinthemannerdescribedinChapter3.)
Page159
EXHIBIT49
AdjustingEntries
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d
OVERNIGHTAUTOSERVICE
GENERALJOURNAL
DECEMBER31,2015
Date
AccountTitlesandExplanation
DebitCredit
2015
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Dec.31SuppliesExpense...................................
600
ShopSupplies..................................
600
Decembershopsuppliesadjustment.
31InsuranceExpense..................................
1,500
UnexpiredInsurance.............................
1,500
DecemberInsuranceadjustment.
31DepreciationExpense:Building........................
150
AccumulatedDepreciation:Building.................
150
Decemberdepreciationadjustmentonbuildings($36,000240mo.).
31DepreciationExpense:ToolsandEquipment..............
200
AccumulatedDepreciation:ToolsandEquipment.......
200
Decemberdepreciationadjustmentontoolsandequipment($12,00060mo.).
31UnearnedRentRevenue..............................
3,000
RentRevenueEarned............................
3,000
Decemberunearnedrevenueadjustment($9,0003mo.).
31WagesExpense.....................................
WagesPayable..................................
1,950
1,950
Decemberadjustmenttoaccruewagespayable.
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31InterestExpense.....
30
InterestPayable.................................
30
Decemberadjustmenttoaccrueinterestpayable($4,000.091/12).
31AccountsReceivable.................................
750
RepairServiceRevenue...........................
750
Decemberadjustmenttoaccruerepairservicerevenue.
31IncomeTaxesExpense...............................
IncomeTaxesPayable............................
4,020
4,020
Decemberadjustmenttoaccrueincometaxespayable.
EXHIBIT49
AdjustingEntries
Adjustingentriesarerecordedonlyattheendoftheperiod
Aftertheseadjustmentsarepostedtotheledger,Overnight'sledgeraccountswillbeuptodate(except
forthebalanceintheRetainedEarningsaccount).9Thecompany'sadjustedtrialbalanceatDecember
31,2015,appearsinEXHIBIT410.(Foremphasis,thoseaccountsaffectedbythemonthendadjusting
entriesareshowninred.)
EXHIBIT410
AdjustedTrialBalance
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EXHIBIT410
Page160
Overnight'sfinancialstatementsareprepareddirectlyfromtheadjustedtrialbalance.Notetheorderof
theaccounts:Allbalancesheetaccountsarefollowedbythestatementofretainedearningsaccountsand
thentheincomestatementaccounts.InChapter5,weillustrateexactlyhowthesethreefinancial
statementsareprepared.
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ConcludingRemarks
LO49
LO49
LEARNINGOBJECTIVE
Prepareanadjustedtrialbalanceanddescribeitspurpose.
Throughoutthischapter,weillustratedendofperiodadjustingentriesarisingfromtimingdifferences
betweencashflowsandrevenueorexpenserecognition.Inshort,theadjustingprocesshelpstoensure
thatappropriateamountsofrevenueandexpensearemeasuredandreportedinacompany'sincome
statement.
InChapter5,wecontinuewithourillustrationofOvernightAutoServiceanddemonstratehowadjusting
entriesarereflectedthroughoutacompany'sfinancialstatements.
Laterchaptersexplainwhyaccurateincomemeasurementisofcriticalimportancetoinvestorsand
creditorsinestimatingthetimingandamountsofacompany'sfuturecashflows.Wealsoillustratehow
understandingcertaintimingdifferencesenablesmanagerstobudgetandtoplanforfutureoperations.
Page161
Ethics,Fraud,&CorporateGovernance
ImproperaccountingforoperatingcostshasoftenresultedintheSECbringingactionagainstcompanies
forfraudulentfinancialreporting.Expendituresthatareexpectedonlytobenefittheyearinwhichthey
aremadeshouldbeexpensed(deductedfromrevenueinthedeterminationofnetincomeforthecurrent
period).Companiesthatengageinfraudwilloftendefertheseexpendituresbycapitalizingthem(they
debitanassetaccountreportedinthebalancesheetinsteadofanexpenseaccountreportedintheincome
statement).
PriortoEnronandWorldCom,oneofthelargestfinancialscandalsinU.S.historyoccurredatWaste
Management.WasteManagementwastheworld'slargestwasteservicescompany.Theimproper
accountingatWasteManagementlastedforapproximatelyfiveyearsandresultedinanoverstatement
ofearningsduringthistimeperiodof$1.7billion.Investorslostover$6billionwhenWaste
Management'simproperaccountingwasrevealed.
WasteManagement'sschemeforoverstatingearningswassimple.Thecompanydeferredrecognizing
normaloperatingexpendituresasexpensesuntilfutureperiods.Theseimproperdeferralswere
accomplishedinanumberofdifferentways,manyofwhichinvolvedimproperaccountingforlongterm
assets.Forexample,WasteManagementincurredcostsinbuyinganddevelopinglandtobeusedas
landfills(i.e.,garbagedumps).Capitalizingthesecoststreatingthemaslongtermassetswasproper
accounting.However,incertaincases,thecompanywasnotabletosecurethenecessarygovernmental
permitsandapprovalstousethepurchasedlandasintended.Inthesecases,thecoststhathadbeen
capitalizedandreportedaslandfillsinthebalancesheetshouldhavebeenexpensedimmediately,thereby
reducingnetincomefortheyearinwhichthecompany'sfailuretoobtaingovernmentpermitsand
approvalsoccurred.
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ENDOFCHAPTERREVIEW
SUMMARYOFLEARNINGOBJECTIVES
LO41Explainthepurposeofadjustingentries.Thepurposeofadjustingentriesistoallocate
revenueandexpensesamongaccountingperiodsinaccordancewiththerealizationandmatching
principles.Theseendofperiodentriesarenecessarybecauserevenuemaybeearnedandexpensesmay
beincurredinperiodsotherthantheperiodinwhichrelatedcashflowsarerecorded.
LO42Describeandpreparethefourbasictypesofadjustingentries.Thefourbasictypesof
adjustingentriesaremadeto(1)convertassetstoexpenses,(2)convertliabilitiestorevenue,(3)accrue
unpaidexpenses,and(4)accrueuncollectedrevenue.Oftenatransactionaffectstherevenueorexpenses
oftwoormoreaccountingperiods.Therelatedcashinfloworoutflowdoesnotalwayscoincidewiththe
periodinwhichtheserevenueorexpenseitemsarerecorded.Thus,theneedforadjustingentriesresults
fromtimingdifferencesbetweenthereceiptordisbursementofcashandtherecordingofrevenueor
expenses.
LO43Prepareadjustingentriestoconvertassetstoexpenses.Whenanexpenditureismadethat
willbenefitmorethanoneaccountingperiod,anassetaccountisdebitedandcashiscredited.Theasset
accountisusedtodefer(orpostpone)expenserecognitionuntilalaterdate.Attheendofeachperiod
benefitingfromthisexpenditure,anadjustingentryismadetotransferanappropriateamountfromthe
assetaccounttoanexpenseaccount.Thisadjustmentreflectsthefactthatpartoftheasset'scosthasbeen
matchedagainstrevenueinthemeasurementofincomeforthecurrentperiod.
LO44Prepareadjustingentriestoconvertliabilitiestorevenue.Customerssometimespayin
advanceforservicestoberenderedinlateraccountingperiods.Foraccountingpurposes,thecash
receiveddoesnotrepresentrevenueuntilithasbeenearned.Thus,therecognitionofrevenuemustbe
deferreduntilitisearned.AdvancecollectionsfromcustomersarerecordedbydebitingCashandby
creditingaliabilityaccountforunearnedrevenue.ThisliabilityissometimescalledCustomerDeposits,
AdvanceSales,orDeferredRevenue.Asunearnedrevenuebecomesearned,anadjustingentryismade
attheendofeachperiodtotransferanappropriateamountfromtheliabilityaccounttoarevenue
account.Thisadjustmentreflectsthefactthatallorpartofthecompany'sobligationtoitscustomershas
beenfulfilledandthatrevenuehasbeenrealized.
LO45Prepareadjustingentriestoaccrueunpaidexpenses.Someexpensesaccumulate(oraccrue)
inthecurrentperiodbutarenotpaiduntilafutureperiod.Theseaccruedexpensesarerecordedaspartof
theadjustingprocessattheendofeachperiodbydebitingtheappropriateexpense(e.g.,SalaryExpense,
InterestExpense,orIncomeTaxesExpense),andbycreditingaliabilityaccount(e.g.,SalariesPayable,
InterestPayable,orIncomeTaxesPayable).Infutureperiods,ascashisdisbursedinsettlementofthese
liabilities,theappropriateliabilityaccountisdebitedandCashiscredited.Note:Recordingtheaccrued
expenseinthecurrentperiodistheadjustingentry.Recordingthedisbursementofcashinafutureperiod
isnotconsideredanadjustingentry.
LO46Prepareadjustingentriestoaccrueuncollectedrevenue.Somerevenuesareearned(or
accrued)inthecurrentperiodbutarenotcollecteduntilafutureperiod.Theserevenuesarenormally
recordedaspartoftheadjustingprocessattheendofeachperiodbydebitinganassetaccountcalled
AccountsReceivable,andbycreditingtheappropriaterevenueaccount.Infutureperiods,ascashis
collectedinsettlementofoutstandingreceivables,CashisdebitedandAccountsReceivableiscredited.
Note:Recordingtheaccruedrevenueinthecurrentperiodistheadjustingentry.Recordingthereceiptof
cashinafutureperiodisnotconsideredanadjustingentry.
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LO47Explainhowtheprinciplesofrealizationandmatchingrelatetoadjustingentries.Adjusting
entriesarethetoolsbywhichaccountantsapplytherealizationandmatchingprinciples.Throughthese
entries,revenuesarerecognizedastheyareearned,andexpensesarerecognizedasresourcesareusedor
consumedinproducingtherelatedrevenue.
LO48Explaintheconceptofmateriality.Theconceptofmaterialityallowsaccountantstouse
estimatedamountsandtoignorecertainaccountingprinciplesiftheseactionswillnothaveamaterial
effectonthefinancialstatements.Amaterialeffectisonethatmightreasonablybeexpectedtoinfluence
thedecisionsmadebytheusersoffinancialstatements.Thus,accountantsmayaccountforimmaterial
itemsandeventsintheeasiestandmostconvenientmanner.
LO49Prepareanadjustedtrialbalanceanddescribeitspurpose.Theadjustedtrialbalancereports
allofthebalancesinthegeneralledgeraftertheendofperiodadjustingentrieshavebeenmadeand
posted.Generally,allofacompany'sbalancesheetaccountsarelisted,followedbythestatementof
retainedearningsaccountsand,finally,theincomestatementaccounts.Theamountsshowninthe
adjustedtrialbalancearecarriedforwarddirectlytothefinancialstatements.Theadjustedtrialbalanceis
notconsideredoneofthefourgeneralpurposefinancialstatementsintroducedinChapter2.Rather,itis
simplyaschedule(orworksheet)usedinpreparingthefinancialstatements.
Page163
KeyTermsIntroducedorEmphasizedinChapter4
accrue(p.152)Togroworaccumulateovertime:forexample,interestexpense.
accumulateddepreciation(p.150)Acontraassetaccountshownasadeductionfromtherelatedasset
accountinthebalancesheet.Depreciationtakenthroughouttheusefullifeofanassetisaccumulatedin
thisaccount.
adjustedtrialbalance(p.159)Ascheduleindicatingthebalancesinledgeraccountsafterendofperiod
adjustingentrieshavebeenposted.Theamountsshownintheadjustedtrialbalancearecarrieddirectly
intofinancialstatements.
adjustingentries(p.142)Entriesmadeattheendoftheaccountingperiodforthepurposeof
recognizingrevenueandexpensesthatarenotproperlymeasuredasaresultofjournalizingtransactions
astheyoccur.
bookvalue(p.150)Thenetamountatwhichanassetappearsinfinancialstatements.Fordepreciable
assets,bookvaluerepresentscostminusaccumulateddepreciation.Alsocalledcarryingvalue.
contraassetaccount(p.150)Anaccountwithacreditbalancethatisoffsetagainstordeductedfroman
assetaccounttoproducetheproperbalancesheetamountfortheasset.
depreciableassets(p.148)Physicalobjectswithalimitedlife.Thecostoftheseassetsisgradually
recognizedasdepreciationexpense.
depreciation(p.148)Thesystematicallocationofthecostofanassettoexpenseduringtheperiodsof
itsusefullife.
immaterial(p.157)Somethingoflittleornoconsequence.Immaterialitemsmaybeaccountedforinthe
mostconvenientmanner,withoutregardtoothertheoreticalconcepts.
matching(principle)(p.156)Theaccountingprincipleofoffsettingrevenuewiththeexpensesincurred
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inproducingthatrevenue.Requiresrecognitionofexpensesintheperiodsthatthegoodsandservicesare
usedintheefforttoproducerevenue.
materiality(p.157)Therelativeimportanceofanitemoramount.Itemssignificantenoughtoinfluence
decisionsaresaidtobematerial.Itemslackingthisimportanceareconsideredimmaterial.The
accountingtreatmentaccordedtoimmaterialitemsmaybeguidedbyconvenienceratherthanby
theoreticalprinciples.
prepaidexpenses(p.146)Assetsrepresentingadvancepaymentoftheexpensesoffutureaccounting
periods.Astimepasses,adjustingentriesaremadetotransfertherelatedcostsfromtheassetaccountto
anexpenseaccount.
realization(principle)(p.156)Theaccountingprinciplethatgovernsthetimingofrevenuerecognition.
Basically,theprincipleindicatesthatrevenueshouldberecognizedintheperiodinwhichitisearned.
straightlinemethodofdepreciation(p.149)Thewidelyusedapproachofrecognizinganequal
amountofdepreciationexpenseineachperiodofadepreciableasset'susefullife.
unearnedrevenue(p.151)Anobligationtodelivergoodsorrenderservicesinthefuture,stemming
fromthereceiptofadvancepayment.
usefullife(p.148)Theperiodoftimethatadepreciableassetisexpectedtobeusefultothebusiness.
Thisistheperiodoverwhichthecostoftheassetisallocatedtodepreciationexpense.
DemonstrationProblem
InternetConsultingService,Inc.,adjustsitsaccountseverymonth.Onthefollowingpageisthe
company'syearendunadjustedtrialbalancedatedDecember31,2015.(Bearinmindthatadjusting
entriesalreadyhavebeenmadeforthefirst11monthsof2015,buthavenotbeenmadeforDecember.)
OtherData
1. OnDecember1,thecompanysignedanewrentalagreementandpaidthreemonths'rentin
advanceatarateof$2,100permonth.ThisadvancepaymentwasdebitedtothePrepaidOffice
Rentaccount.
2. DuesandsubscriptionsexpiringduringDecemberamountedto$50.
3. AnestimateofsuppliesonhandwasmadeatDecember31theestimatedcostoftheunused
supplieswas$450.
4. Theusefullifeoftheequipmenthasbeenestimatedatfiveyears(60months)fromdateof
acquisition.
5. Accruedinterestonnotespayableamountedto$100atyearend.(SetupaccountsforInterest
ExpenseandforInterestPayable.)
6. Consultingservicesvaluedat$2,850wererenderedduringDecembertoclientswhohadmade
paymentinadvance.
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INTERNETCONSULTINGSERVICE,INC.
UNADJUSTEDTRIALBALANCE
DECEMBER31,2015
Cash........................................ $49,100
Consultingfeesreceivable.......................
23,400
Prepaidofficerent..............................
6,300
Prepaidduesandsubscriptions...................
300
Supplies......................................
600
Equipment....................................
36,000
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Accumulateddepreciation:equipment..............
$10,200
Notespayable.................................
5,000
Incometaxespayable...........................
12,000
Unearnedconsultingfees........................
5,950
Capitalstock..................................
30,000
Retainedearnings..............................
32,700
Dividends.....................................
60,000
Consultingfeesearned..........................
257,180
Salariesexpense...............................
88,820
Telephoneexpense.............................
2,550
Rentexpense.................................
22,000
Incometaxesexpense..........................
51,000
Duesandsubscriptionsexpense..................
560
Suppliesexpense..............................
1,600
Depreciationexpense:equipment..................
6,600
Miscellaneousexpenses......................... 4,200
$353,030$353,030
Page164
7. Itisthecustomofthefirmtobillclientsonlywhenconsultingworkiscompletedor,inthecaseof
prolongedengagements,atmonthlyintervals.AtDecember31,consultingservicesvaluedat
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$11,000hadbeenrenderedtoclientsbutnotyetbilled.Noadvancepaymentshadbeenreceived
fromtheseclients.
8. SalariesearnedbyemployeesbutnotpaidasofDecember31amountto$1,700.
9. Incometaxesexpensefortheyearisestimatedat$56,000.Ofthisamount,$51,000hasbeen
recognizedasexpenseinpriormonths,and$39,000hasbeenpaidtotaxauthorities.Thecompany
planstopaythe$17,000remainderofitsincometaxliabilityonJanuary15.
Instructions
1. PreparethenecessaryadjustingjournalentriesonDecember31,2015.
2. Determinetheamountstobereportedinthecompany'syearendadjustedtrialbalanceforeachof
thefollowingaccounts:
ConsultingFeesEarnedDuesandSubscriptionsExpense
SalariesExpense
DepreciationExpense:Equipment
TelephoneExpense
MiscellaneousExpenses
RentExpense
InterestExpense
SuppliesExpense
IncomeTaxesExpense
3. Determinethecompany'snetincomefortheyearendedDecember31,2015.(Hint:Usethe
amountsdeterminedinpartbabove.)
Page165
SolutiontotheDemonstrationProblem
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1.
d
GENERALJOURNAL
DECEMBER31,2015
Date
AccountTitlesandExplanation
DebitCredit
RentExpense...............................
2,100
Dec.31
2015
1.
PrepaidOfficeRent.......................
2,100
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Decemberrentadjustment.
2.
DuesandSubscriptionsExpense................
50
PrepaidDuesandSubscriptions.............
50
Decemberduesandsubscriptionsadjustment.
3.
SuppliesExpense............................
150
Supplies................................
150
Decembersuppliesadjustment.
4.
DepreciationExpense:Equipment...............
600
AccumulatedDepreciation:Equipment........
600
Decemberdepreciationadjustment($36,00060mos.).
5.
InterestExpense.............................
100
InterestPayable..........................
100
Decemberinterestadjustment.
6.
UnearnedConsultingFees.....................
2,850
ConsultingFeesEarned....................
2,850
Decemberunearnedrevenueadjustment.
7.
ConsultingFeesReceivable....................
ConsultingFeesEarned....................
11,000
11,000
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Decemberaccruedrevenueadjustment.
8.
SalariesExpense.............................
1,700
SalariesPayable..........................
1,700
Decembersalariesadjustment.
9.
IncomeTaxesExpense........................
5,000
IncomeTaxesPayable.....................
5,000
Decemberincometaxexpenseadjustment.
Page166
2.
d
ADJUSTEDTRIALBALANCE
DECEMBER31,2015
UnadjustedTrialBalance +Adjustment=
Amount
Amount
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ConsultingFees
Earned
$257,180
(6)$2,850
(7)$11,000
$271,030
(8)$1,700
$90,520
SalariesExpense
$88,820
TelephoneExpense
$2,550 None
$2,550
RentExpense
$22,000
(1)$2,100
$24,100
SuppliesExpense
$1,600 (3)$150
$1,750
$560 (2)$50
$610
Equipment
$6,600 (4)$600
$7,200
Miscellaneous
Expenses
$4,200 None
$4,200
Duesand
Subscriptions
Expense
Depreciation
Expense:
InterestExpense
None
IncomeTaxes
Expense
$51,000
(5)$100
$100
(9)$5,000
$56,000
3. Usingthefigurescomputedinpartb,netincomefortheyeariscomputedasfollows:
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ConsultingFeesEarned.................................
$271,030
SalariesExpense....................................... $90,520
TelephoneExpense.....................................
2,550
RentExpense......................................... 24,100
SuppliesExpense......................................
1,750
DuesandSubscriptions
Expense............................................
610
DepreciationExpense:
Equipment..........................................
7,200
MiscellaneousExpenses.................................
4,200
InterestExpense.......................................
100
IncomeTaxesExpense.................................. 56,000(187,030)
NetIncome...........................................
$84,000
SelfTestQuestions
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Theanswerstothesequestionsappearonpage191.
1. Thepurposeofadjustingentriesisto:
1. AdjusttheRetainedEarningsaccountfortherevenue,expense,anddividendsrecorded
duringtheaccountingperiod.
2. Adjustdailythebalancesinasset,liability,revenue,andexpenseaccountsfortheeffectsof
businesstransactions.
3. Applytherealizationprincipleandthematchingprincipletotransactionsaffectingtwoor
moreaccountingperiods.
4. Preparerevenueandexpenseaccountsforrecordingthetransactionsofthenextaccounting
period.
Answer
2. Beforemonthendadjustmentsaremade,theJanuary31trialbalanceofRoverExcursionscontains
revenueof$27,900andexpensesof$17,340.Adjustmentsarenecessaryforthefollowingitems:
PortionofprepaidrentapplicabletoJanuary,$2,700
DepreciationforJanuary,$1,440
PortionoffeescollectedinadvanceearnedinJanuary,$3,300
Page167
FeesearnedinJanuary,notyetbilledtocustomers,$1,950
NetincomeforJanuaryis:
1. $10,560.
2. $17,070.
3. $7,770.
4. Someotheramount.
Answer
3. TheCPAfirmauditingMasonStreetRecordingStudiosfoundthattotalstockholders'equitywas
understatedandliabilitieswereoverstated.Whichofthefollowingerrorscouldhavebeenthe
cause?
1. Makingtheadjustmententryfordepreciationexpensetwice.
2. Failuretorecordinterestaccruedonanotepayable.
3. Failuretomaketheadjustingentrytorecordrevenuethathadbeenearnedbutnotyetbilled
toclients.
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4. Failuretorecordtheearnedportionoffeesreceivedinadvance.
Answer
4. AssumeFisherCorporationusuallyearnstaxableincome,butsustainsalossinthecurrentperiod.
Theentrytorecordincometaxesexpenseinthecurrentperiodwillmostlikely(indicateallcorrect
answers):
1. Increasetheamountofthatloss.
2. IncludeacredittotheIncomeTaxesExpenseaccount.
3. Beanadjustingentry,ratherthananentrytorecordatransactioncompletedduringthe
period.
4. IncludeacredittoIncomeTaxesPayable.
Answer
5. Theconceptofmateriality(indicateallcorrectanswers):
1. Requiresthatfinancialstatementsbeaccuratetothenearestdollar,butneednotshowcents.
2. Isbaseduponwhatusersoffinancialstatementsarethoughttoconsiderimportant.
3. Permitsaccountantstoignoregenerallyacceptedaccountingprinciplesincertainsituations.
4. Permitsaccountantstousetheeasiestandmostconvenientmeansofaccountingforevents
thatareimmaterial.
Answer
ASSIGNMENTMATERIALDiscussionQuestions
1. Whatisthepurposeofmakingadjustingentries?Youranswershouldrelateadjustingentriestothe
goalsofaccrualaccounting.
2. Doadjustingentriesaffectincomestatementaccounts,balancesheetaccounts,orboth?Explain.
3. Whydoestherecordingofadjustingentriesrequireabetterunderstandingoftheconceptsof
accrualaccountingthandoestherecordingofroutinerevenueandexpensetransactionsoccurring
throughouttheperiod?
4. Whydoesthepurchaseofaoneyearinsurancepolicyfourmonthsagogiverisetoinsurance
expenseinthecurrentmonth?
5. Ifserviceshavebeenrenderedtocustomersduringthecurrentaccountingperiodbutnorevenue
hasbeenrecordedandnobillhasbeensenttothecustomers,whyisanadjustingentryneeded?
Whattypesofaccountsshouldbedebitedandcreditedbythisentry?
6. Whatismeantbythetermunearnedrevenue?Whereshouldanunearnedrevenueaccountappear
inthefinancialstatements?Astheworkisdone,whathappenstothebalanceofanunearned
revenueaccount?
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7. Brieflyexplaintheconceptofmateriality.Ifanitemisnotmaterial,howistheitemtreatedfor
financialreportingpurposes?
8. Discusstherealizationprincipleandhowitisappliedintherecognitionofrevenue.Doesthe
receiptofcashforcustomersnecessarilycoincidewiththerecognitionofrevenue?Explain.
9. Discussthematchingprincipleandhowitisappliedintherecognitionofexpenses.Doesthe
paymentofcashnecessarilycoincidewiththerecognitionofanexpense?Explain.
10. Woulda$1,000expenditurebeconsideredmaterialtoallbusinesses?Explain.
11. Listvariousaccountsinthebalancesheetthatrepresentdeferredexpenses.
12. Howisdeferredrevenuereportedinthebalancesheet?
13. Howdoaccruedbutunpaidexpensesaffectthebalancesheet?
14. Howdoesaccruedbutuncollectedrevenueaffectthebalancesheet?
15. ExplainhowRoyalCaribbeanaccountsforcustomerdepositsaspassengerspurchasecruise
ticketsinadvance.
BriefExercises
LO43,LO44
OnNovember1,GirtzCorporationpurchasedasixmonthinsurancepolicyfrom
BRIEFEXERCISE TheTompteeAgencyfor$4,500.
4.1
1. PreparethenecessaryadjustingentryforGirtzCorporationonNovember
PrepaidExpenses
30,assumingitrecordedtheNovember1expenditureasUnexpired
andUnearned
Insurance.
Revenue
2. PreparethenecessaryadjustingentryforTheTompteeAgencyon
LO43,LO44
November30,assumingitrecordedGirtz'spaymentasUnearnedInsurance
Premiums.
Page168
LO43,LO44
BRIEF
EXERCISE4.2
OnFebruary1,WatsonStorageagreedtorentHillbourneManufacturingwarehouse
spacefor$300permonth.HillbourneManufacturingpaidthefirstthreemonths'rent
inadvance.
PrepaidExpenses
andUnearned
Revenue
1. PreparethenecessaryadjustingentryforHillbourneManufacturingon
February28,assumingitrecordedtheexpenditureonFebruary1asPrepaid
Rent.
LO43,LO44
2. PreparethenecessaryadjustingentryforWatsonStorageonFebruary28,
assumingitrecordedHillbourneManufacturing'spaymentasUnearnedRent
Revenue.
LO43
BRIEF
OnMarch1,PhonicCorporationhadofficesuppliesonhandof$1,000.Duringthemonth,
Phonicpurchasedadditionalsuppliescosting$500.Approximately$200ofunusedoffice
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EXERCISE suppliesremainonhandattheendofthemonth.
4.3
PreparethenecessaryadjustingentryonMarch31toaccountforofficesupplies.
Accounting
for
Supplies
LO43
LO43
BRIEF
EXERCISE4.4
Accountingfor
Depreciation
LO43
OnJanuary2,2010,HagenCorporationpurchasedequipmentcosting$144,000.
Hagenperformsadjustingentriesmonthly.
1. Recordthisequipment'sdepreciationexpenseonDecember31,2015,assuming
itsestimatedlifewaseightyearsonJanuary2,2010.
2. Determinetheamountoftheequipment'saccumulateddepreciationreportedin
thebalancesheetdatedDecember31,2015.
LO46
Ted'sTaxServicehadearnedbutnotyetrecordedthefollowingclientservice
BRIEFEXERCISE revenueattheendofthecurrentaccountingperiod:
4.5
Accruing
Uncollected
Revenue
LO46
AccountNumberHoursBillableHourlyBillingRate
Account#4067
$80
Account#3940
15
$60
Account#1852
18
$95
PreparethenecessaryadjustingentrytorecordTed'sunbilledclientservice
revenue.
LO44
Jasper'sunadjustedtrialbalancereportsUnearnedClientRevenueof$4,000andClient
BRIEF
RevenueEarnedof$30,000.Anexaminationofclientrecordsrevealsthat$2,500of
EXERCISE previouslyunearnedrevenuehasnowbeenearned.
4.6
1. Preparethenecessaryadjustingentrypertainingtotheseaccounts.
Unearned
2. AtwhatamountwillClientRevenueEarnedbereportedinJasper'sincome
Revenue
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statement?
LO45
MilfordCorporationpaysitsemployeesonthefifteenthofeachmonth.Accrued,but
BRIEF
unpaid,salariesonDecember31,2015,totaled$175,000.SalariesearnedbyMilford's
EXERCISE employeesfromJanuary1throughJanuary15,2016,totaled$180,000.
4.7
1. PreparethenecessaryadjustingentryforsalariesexpenseonDecember31,2015.
Accruing
2. Recordthecompany'spaymentofsalariesonJanuary15,2016.
Unpaid
Salaries
LO45
LO45
JumpCorporationborrowed$60,000onDecember1,2015,byissuingatwomonth,4
BRIEF
percentnotepayabletoServiceOneCreditUnion.Theentireamountoftheloan,plus
EXERCISE interest,isdueFebruary1,2016.
4.8
1. PreparethenecessaryadjustingentryforinterestexpenseonDecember31,2015.
Accruing
2. RecordtherepaymentoftheloanplusinterestonFebruary1,2016.
Unpaid
Interest
LO45
LO45
Hunter'sunadjustedtrialbalancedatedDecember31,2015,reportsIncomeTaxesExpense
BRIEF
of$70,000,andIncomeTaxesPayableof$20,000.Thecompany'saccountantestimates
EXERCISE thatincometaxesexpensefortheentireyearendedDecember31,2015,is$85,000.
4.9
1. PreparethenecessaryadjustingentryforincometaxesexpenseonDecember31,
Accruing
2015.
Unpaid
2. Determinetheamountofincometaxespayablereportedinthebalancesheetdated
Income
December31,2015.
Taxes
LO45
LO48
BRIEF
EXERCISE
4.10
Conceptof
Materiality
Theconceptofmaterialityisanunderlyingprincipleoffinancialreporting.
1. Brieflyexplaintheconceptofmateriality.
2. Is$2,500amaterialdollaramount?Explain.
3. Describetwowaysinwhichtheconceptofmaterialitymaysaveaccountants'
timeandeffortinmakingadjustingentries.
LO48
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Exercises
LO41
through
LO49
IEBWireframe
Listedbelowareninetechnicalaccountingtermsusedinthischapter:
EXERCISE
4.1
Accounting UnrecordedrevenueAdjustingentries Accruedexpenses
Terminology
LO41
through
LO49
Bookvalue
MatchingprincipleAccumulateddepreciation
Unearnedrevenue Materiality
Prepaidexpenses
Eachofthefollowingstatementsmay(ormaynot)describeoneofthesetechnicalterms.
Foreachstatement,indicatetheaccountingtermdescribed,oranswerNoneifthe
statementdoesnotcorrectlydescribeanyoftheterms.
1. Thenetamountatwhichanassetiscarriedintheaccountingrecordsas
distinguishedfromitsmarketvalue.
2. Anaccountingconceptthatmayjustifydeparturefromotheraccountingprinciples
forpurposesofconvenienceandeconomy.
3. Theoffsettingofrevenuewithexpensesincurredingeneratingthatrevenue.
4. Revenueearnedduringthecurrentaccountingperiodbutnotyetrecordedorbilled,
whichrequiresanadjustingentryattheendoftheperiod.
5. Entriesmadeattheendoftheperiodtoachievethegoalsofaccrualaccountingby
recordingrevenuewhenitisearnedandbyrecordingexpenseswhentherelated
goodsandservicesareused.
6. Atypeofaccountcreditedwhencustomerspayinadvanceforservicestobe
renderedinthefuture.
7. Abalancesheetcategoryusedforreportingadvancepaymentsofsuchitemsas
insurance,rent,andofficesupplies.
8. Anexpenserepresentingthesystematicallocationofanasset'scostoveritsuseful
life.
LO41
through
LO46,
LO49
EXERCISE
4.2
SecurityServiceCompanyadjustsitsaccountsattheendofthemonth.OnNovember30,
adjustingentriesarepreparedtorecord:
1. DepreciationexpenseforNovember.
2. InterestexpensethathasaccruedduringNovember.
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Effectsof
Adjusting
Entries
3. RevenueearnedduringNovemberthathasnotyetbeenbilledtocustomers.
4. Salaries,payabletocompanyemployees,thathaveaccruedsincethelastpaydayin
November.
LO41
through
LO46,
LO49
5. Theportionofthecompany'sprepaidinsurancethathasexpiredduringNovember.
6. Earningaportionoftheamountcollectedinadvancefromacustomer,Harbor
Restaurant.
Indicatetheeffectofeachoftheseadjustingentriesonthemajorelementsofthecompany's
incomestatementandbalancesheetthatis,onrevenue,expenses,netincome,assets,
liabilities,andowners'equity.Organizeyouranswerintabularform,usingthecolumn
headingsshownandthesymbolsIforincrease,Dfordecrease,andNEfornoeffect.The
answerforadjustingentryaisprovidedasanexample.
IncomeStatement
BalanceSheet
AdjustingEntryRevenueExpenses=NetIncomeAssets=Liabilities+Owners'Equity
a
LO41throughLO47
EXERCISE4.3
PreparingAdjusting
EntriestoConvertan
AssettoanExpenseand
toConvertaLiabilityto
Revenue
LO41throughLO47
NE
NE
TheFreemontFlyers,aprofessionalsoccerteam,preparesfinancial
statementsonamonthlybasis.ThesoccerseasonbeginsinMay,butinApril
theteamengagedinthefollowingtransactions:
1. Paid$1,500,000tothemunicipalstadiumasadvancerentforuseofthe
facilitiesforthesixmonthperiodfromMay1throughOctober31.
ThispaymentwasinitiallyrecordedasPrepaidRent.
2. Collected$6,000,000cashfromthesaleofseasonticketsfortheteam's
homegames.TheentireamountwasinitiallyrecordedasUnearned
TicketRevenue.DuringthemonthofMay,theteamplayedseveral
homegamesatwhich$750,000oftheseasonticketssoldinAprilwere
usedbyfans.
PreparethetwoadjustingentriesrequiredonMay31.
Page170
LO41through
LO47
EXERCISE4.4
RoyalCaribbeanisoneoftheworld'slargestcruiselinecompanies.Itsprinting
costsforbrochuresareinitiallyrecordedasPrepaidAdvertisingandarelater
chargedtoAdvertisingExpensewhentheyaremailed.Passengerdepositsfor
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Preparing
upcomingcruisesareconsideredunearnedrevenueandarerecordedasCustomer
AdjustingEntries Depositsascashisreceived.DepositedamountsarelaterconvertedtoCruise
toConvertan
Revenueasvoyagesarecompleted.
Assettoan
1. WhereinitsfinancialstatementsdoesRoyalCaribbeanreportPrepaid
Expenseandto
Advertising?WhereinitsfinancialstatementsdoesitreportCustomer
ConvertaLiability
Deposits?
toRevenue
LO41through
LO47
2. Preparetheadjustingentrynecessarywhenbrochurescosting$2millionare
mailed.
3. Initsmostrecentannualreport,RoyalCaribbeanreportedCustomer
Depositsof$1.5billion.Preparetheadjustingentrynecessaryinthe
followingyearas$40millionofthisamountisearned.
4. ConsidertheentireadjustingprocessatRoyalCaribbean.Whichadjusting
entrydoyouthinkresultsinthemostsignificantexpensereportedinthe
company'sincomestatement?
LO41throughLO47
EXERCISE4.5
PreparingAdjustingEntries
toAccrueRevenueand
ExpensesforWhichNo
CashHasBeenReceived
LO41throughLO47
ThegeologicalconsultingfirmofGilbert,Marsh,&Kesterprepares
adjustingentriesonamonthlybasis.Amongtheitemsrequiring
adjustmentonDecember31,2015,arethefollowing:
1. Thecompanyhasoutstandinga$50,000,9percent,twoyearnote
payableissuedonJuly1,2014.Paymentofthe$50,000note,plus
allaccruedinterestforthetwoyearloanperiod,isdueinfullon
June30,2016.
2. ThefirmisprovidingconsultingservicestoTexasOilCompanyat
anagreeduponrateof$1,000perday.AtDecember31,10daysof
unbilledconsultingserviceshavebeenprovided.
1. PreparethetwoadjustingentriesrequiredonDecember31torecord
theaccruedinterestexpenseandtheaccruedconsultingrevenue
earned.
2. Assumethatthe$50,000notepayableplusallaccruedinterestare
paidinfullonJune30,2016.Whatportionofthetotalinterest
expenseassociatedwiththisnotewillbereportedinthefirm's2016
incomestatement?
3. AssumethatonJanuary30,2016,Gilbert,Marsh,&Kesterreceive
$25,000fromTexasOilCompanyinfullpaymentoftheconsulting
servicesprovidedinDecemberandJanuary.Whatportionofthis
amountconstitutesrevenueearnedinJanuary?
LO41,
LO42,
LO44
WhenAmericanAirlinessellsticketsforfutureflights,itdebitsCashandcreditsan
accountentitledAirTrafficLiability(asopposedtocreditingPassengerRevenueEarned).
Thisaccount,reportedrecentlyatnearly$4.5billion,isamongthelargestliabilities
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EXERCISE appearinginthecompany'sbalancesheet.
4.6
1. Explainwhythisliabilityisoftenreferredtoasadeferredrevenueaccount.
Deferred
2. Whatactivitynormallyreducesthisliability?Canyouthinkofanyothertransaction
Revenue
thatwouldalsoreducethisaccount?
LO41,
3. Assumethat,inarecentflight,passengersoftheairlineusedticketsthattheyhad
LO42,
purchasedinadvancefor$87,500.RecordtheentryAmericanAirlineswouldmake
LO44
uponcompletionofthisflight.
LO41
through
LO46,
LO49
EXERCISE
4.7
Preparing
Various
Adjusting
Entries
LO41
through
LO46,
LO49
Sweeney&Allen,alargemarketingfirm,adjustsitsaccountsattheendofeachmonth.
ThefollowinginformationisavailablefortheyearendingDecember31,2015:
1. AbankloanhadbeenobtainedonDecember1.Accruedinterestontheloanat
December31amountsto$1,500.Nointerestexpensehasyetbeenrecorded.
2. Depreciationofthefirm'sofficebuildingisbasedonanestimatedlifeof30years.
Thebuildingwaspurchasedin2011for$450,000.
3. Accrued,butunbilled,revenueduringDecemberamountsto$75,000.
4. OnMarch1,thefirmpaid$2,400torenewa12monthinsurancepolicy.Theentire
amountwasrecordedasPrepaidInsurance.
5. Thefirmreceived$15,000fromKingBiscuitCompanyinadvanceofdevelopinga
sixmonthmarketingcampaign.Theentireamountwasinitiallyrecordedas
UnearnedRevenue.AtDecember31,$9,000hadactuallybeenearnedbythefirm.
6. Thecompany'spolicyistopayitsemployeeseveryFriday.SinceDecember31fell
onaWednesday,therewasanaccruedliabilityforsalariesamountingto$1,900.
1. RecordthenecessaryadjustingjournalentriesonDecember31,2015.
Page171
2. ByhowmuchdidSweeney&Allen'snetincomeincreaseordecreaseasaresultof
theadjustingentriesperformedinparta?(Ignoreincometaxes.)
LO41,
LO42,
LO45
EXERCISE
4.8
Notes
Payable
andInterest
JesseCompanyadjustsitsaccountsmonthlyandclosesitsaccountsonDecember31.On
October31,2015,JesseCompanysignedanotepayableandborrowed$150,000froma
bankforaperiodofsixmonthsatanannualinterestrateof6percent.
1. Howmuchisthetotalinterestexpenseoverthelifeofthenote?Howmuchisthe
monthlyinterestexpense?(Assumeequalamountsofinterestexpenseeachmonth.)
2. Inthecompany'sannualbalancesheetatDecember31,2015,whatistheamountof
theliabilitytothebank?
3. PreparethejournalentrytorecordissuanceofthenotepayableonOctober31,2015.
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LO41,
LO42,
LO45
4. PreparetheadjustingentrytoaccrueinterestonthenoteatDecember31,2015.
5. AssumethecompanypreparedabalancesheetatMarch31,2016.Statetheamount
oftheliabilitytothebankatthisdate.
LO41
through
LO47,
LO49
AmongtheledgeraccountsusedbyRapidSpeedwayarethefollowing:PrepaidRent,Rent
Expense,UnearnedAdmissionsRevenue,AdmissionsRevenue,PrepaidPrinting,Printing
Expense,ConcessionsReceivable,andConcessionsRevenue.Foreachofthefollowing
items,providethejournalentry(ifoneisneeded)torecordtheinitialtransactionand
EXERCISE providetheadjustingentry,ifany,requiredonMay31,assumingthecompanymakes
4.9
adjustingentriesmonthly.
Relationship
ofAdjusting
Entriesto
Business
Transactions
LO41
through
LO47,
LO49
LO41,
LO43,
LO44,
LO45,
LO47
EXERCISE
4.10
Adjusting
Entriesand
theBalance
Sheet
LO41,
LO43,
LO44,
LO45,
LO47
1. OnMay1,borrowed$500,000cashfromNationalBankbyissuinga9percentnote
payabledueinthreemonths.
2. OnMay1,paidrentforsixmonthsbeginningMay1at$12,000permonth.
3. OnMay2,soldseasonticketsforatotalof$600,000cash.Theseasonincludes60
racingdays:15inMay,20inJune,and25inJuly.
4. OnMay4,anagreementwasreachedwithSnackBars,Inc.,allowingthatcompany
tosellrefreshmentsatthetrackinreturnfor10percentofthegrossreceiptsfrom
refreshmentsales.
ThefollowinginformationwasreportedinarecentbalancesheetissuedbyMicrosoft
Corporation:
1. Thebookvalueofpropertyandequipmentislistedat$90billion(netof
depreciation).Relatednotestothefinancialstatementsrevealthataccumulated
depreciationonpropertyandequipmenttotals$12billion.
2. Accruedcompensationof$2.9billionislistedasaliability.
3. Shorttermunearnedrevenueisreportedat$18billion,whereaslongtermunearned
revenueisreportedat$1.5billion.Theshorttermfigurewillbeconvertedtorevenue
withinayear.Thelongtermfigurewillbeconvertedtorevenueoverseveralyears.
Relatednotestothefinancialstatementsrevealthatthecompanyengagesin
multiyearleasingofitssoftwareproducts.
1. Determinetheoriginalhistoricalcostofthepropertyandequipmentreportedin
MicrosoftCorporation'sbalancesheet.
2. FourtypesofadjustingentriesareillustratedinExhibit41(page144).Explain
whichtypeofadjustingentryresultedinthecompany'saccruedcompensationfigure.
3. ExplainwhyMicrosoftCorporationreportsunearnedrevenueinitsbalancesheet.
Whymightthecompanyreportshorttermunearnedrevenueseparatelyfromlong
termunearnedrevenue?
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LO41,LO44,
LO47
EXERCISE4.11
Reportingof
UnearnedRevenue
LO41,LO44,
LO47
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Listedbelowaresevencorporationsthatreceivecashfromcustomerspriorto
earningrevenue:
AmericaWestCorporation(airline)
TheNewYorkTimesCompany(newspaper)
RoyalCaribbean(cruisecompany)
Devry,Inc.(forprofittechnicalcollege)
ClearChannelCommunications,Inc.(radiobroadcasting)
AFLACIncorporated(healthinsurance)
BallyTotalFitnessCorporation(fitnessclub)
1. Listedbelowaretheaccountsusedbythesecorporationstoreportunearned
revenue:
DeferredAdvertisingIncome
AirTrafficLiability
DeferredMemberRevenues
CustomerDeposits
UnearnedPremiums
UnexpiredSubscriptions
DeferredTuitionRevenue
Matcheachcorporationwiththeaccounttitleitusestoreportunearned
revenue.
Page172
2. Applytherealizationprincipletoexplainwheneachofthesecorporations
convertsunearnedrevenuetoearnedrevenue.
LO41throughLO47,LO49
EXERCISE4.12
TheunadjustedandadjustedtrialbalancesforTinkerCorporationon
December31,2015,areshownbelow:
PreparingAdjustingEntries
fromaTrialBalance
LO41throughLO47,LO49
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d
TINKERCORPORATION
TRIALBALANCES
DECEMBER31,2015
Unadjusted
Debit
Cash.................... $35,200
.........
Accountsreceivable........
.........
29,120
Credit
Adjusted
Debit
Credit
$35,200
34,120
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Unexpiredinsurance.......
..........
1,200
600
Prepaidrent..............
.........
5,400
3,600
Officesupplies............
.........
680
380
Equipment...............
.........
60,000
60,000
Accumulateddepreciation:
equipment....
$49,000
$50,000
900
900
Notespayable............
..........
5,000
5,000
Interestpayable...........
.........
200
250
Salariespayable...........
.........
2,100
Incometaxespayable.......
.........
1,570
2,170
Unearnedrevenue.........
..........
6,800
3,800
Capitalstock.............
..........
25,000
25,000
Retainedearnings.........
..........
30,000
30,000
Feesearned..............
91,530
99,530
Accountspayable..........
.........
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.........
Advertisingexpense.......
..........
1,500
1,500
Insuranceexpense.........
.........
6,600
7,200
Rentexpense.............
.........
19,800
21,600
Officesuppliesexpense.....
.........
1,200
1,500
Repairsexpense...........
.........
4,800
4,800
Depreciationexpense:
equipment.......
11,000
12,000
Salariesexpense...........
.........
26,300
28,400
Interestexpense...........
.........
200
250
Incometaxesexpense......
.........
7,000
7,600
$210,000 $210,000$218,750 $218,750

Journalizethenineadjustingentriesthatthecompanymadeon
December31,2015.
LO41
through
LO46
Fourtypesofadjustingentrieswereidentifiedinthischapter:
EXERCISE TypeI ConvertingAssetstoExpenses

4.13
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Effectsof
Adjusting
Entries
LO41
through
LO46
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TypeII ConvertingLiabilitiestoRevenue
TypeIIIAccruingUnpaidExpenses
TypeIVAccruingUncollectedRevenue
Completethefollowingtablebyindicatingtheeffectofeachadjustingentrytypeonthe
majorelementsoftheincomestatementandbalancesheet.UsethesymbolsIforincrease,
Dfordecrease,andNEfornoeffect.
Page173
IncomeStatement
BalanceSheet
AdjustmentTypeRevenueExpensesNetIncomeAssetsLiabilitiesOwners'Equity
TypeI
TypeII
TypeIII
TypeIV
LO41
through
LO48
EXERCISE
4.14
Accounting
Principles
LO41
through
LO48
Foreachofthesituationsdescribedbelow,indicatetheunderlyingaccountingprinciplethat
isbeingviolated.Choosefromthefollowingprinciples:
Matching
Cost
Objectivity
Materiality
Realization
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Ifyoudonotbelievethatthepracticeviolatesanyoftheseprinciples,answerNoneand
explain.
1. Thebookkeeperofalargemetropolitanautodealershipdepreciatesthe$7.20costof
metalwastebasketsoveraperiodof10years.
2. Asmallcommuterairlinerecognizesnodepreciationexpenseonitsaircraftbecause
theplanesaremaintainedinasgoodasnewcondition.
3. PalmBeachHotelrecognizesroomrentalrevenueonthedatethatareservationis
received.Forthewinterseason,manyguestsmakereservationsasmuchasayearin
advance.
LO41,LO42
ThefinancialstatementsofHomeDepot,Inc.,appearinAppendixAattheendof
EXERCISE4.15 thistextbook.Examinethecompany'sconsolidatedbalancesheetandidentify
specificaccountsthatmayhaverequiredadjustingentriesattheendoftheyear.
Usingthe
Financial
Statementsof
HomeDepot,Inc.
LO41,LO42
ProblemSetA
LO41
FloridaPalmsCountryClubadjustsitsaccountsmonthly.Clubmemberspaytheirannual
through
duesinadvancebyJanuary4.TheentireamountisinitiallycreditedtoUnearned
LO47
MembershipDues.Attheendofeachmonth,anappropriateportionofthisamountis
PROBLEM creditedtoMembershipDuesEarned.Guestsoftheclubnormallypaygreenfeesbefore
4.1A
beingallowedonthecourse.TheamountscollectedarecreditedtoGreenFeeRevenueat
thetimeofreceipt.Certainguests,however,arebilledforgreenfeesattheendofthe
Preparing month.Thefollowinginformationisavailableasasourceforpreparingadjustingentriesat
Adjusting December31:
Entries
1. Salariesearnedbygolfcourseemployeesthathavenotyetbeenrecordedorpaid
LO41
amountto$9,600.
through
LO47
2. TheTampaUniversitygolfteamusedFloridaPalmsforatournamentplayedon
December30ofthecurrentyear.AtDecember31,the$1,800owedbytheteamfor
greenfeeshadnotyetbeenrecordedorbilled.
3. MembershipduesearnedinDecember,forcollectionsreceivedinJanuary,amountto
$106,000.
4. Depreciationofthecountryclub'sgolfcartsisbasedonanestimatedlifeof15years.
Thecartshadoriginallybeenpurchasedfor$180,000.Thestraightlinemethodis
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used.
(Note:Theclubhousebuildingwasconstructedin1925andisfullydepreciated.)
5. A12monthbankloanintheamountof$45,000hadbeenobtainedbythecountry
clubonNovember1.Interestiscomputedatanannualrateof8percent.Theentire
$45,000,plusalloftheinterestaccruedoverthe12monthlifeoftheloan,isduein
fullonOctober31oftheupcomingyear.Thenecessaryadjustingentrywasmadeon
November30torecordthefirstmonthofaccruedinterestexpense.However,no
adjustmenthasbeenmadetorecordinterestexpenseaccruedinDecember.
Page174
6. AoneyearpropertyinsurancepolicyhadbeenpurchasedonMarch1.Theentire
premiumof$7,800wasinitiallyrecordedasUnexpiredInsurance.
7. InDecember,FloridaPalmsCountryClubenteredintoanagreementtohostthe
annualtournamentoftheFloridaSeniorsGolfAssociation.Thecountryclubexpects
togenerategreenfeesof$4,500fromthisevent.
8. UnrecordedIncomeTaxesExpenseaccruedinDecemberamountsto$19,000.This
amountwillnotbepaiduntilJanuary15.
Instructions
1. Foreachoftheabovenumberedparagraphs,preparethenecessaryadjustingentry
(includinganexplanation).Ifnoadjustingentryisrequired,explainwhy.
2. Fourtypesofadjustingentriesaredescribedatthebeginningofthechapter.Using
thesedescriptions,identifythetypeofeachadjustingentrypreparedinpartaabove.
3. AlthoughFloridaPalms'sclubhousebuildingisfullydepreciated,itisinexcellent
physicalcondition.Explainhowthiscanbe.
LO41
through
LO46,
LO49
PROBLEM
4.2A
Preparing
and
Analyzing
theEffectsof
Adjusting
Entries
LO41
through
LO46,
EnchantedForest,alargecampgroundinSouthCarolina,adjustsitsaccountsmonthly.
Mostguestsofthecampgroundpayatthetimetheycheckout,andtheamountscollected
arecreditedtoCamperRevenue.Thefollowinginformationisavailableasasourcefor
preparingtheadjustingentriesatDecember31:
1. EnchantedForestinvestssomeofitsexcesscashincertificatesofdeposit(CDs)
withitslocalbank.AccruedinterestrevenueonitsCDsatDecember31is$400.
Noneoftheinteresthasyetbeenreceived.(DebitInterestReceivable.)
2. Asixmonthbankloanintheamountof$12,000hadbeenobtainedonSeptember
1.Interestistobecomputedatanannualrateof8.5percentandispayablewhen
theloanbecomesdue.
3. Depreciationonbuildingsownedbythecampgroundisbasedona25yearlife.The
originalcostofthebuildingswas$600,000.TheAccumulatedDepreciation:
Buildingsaccounthasacreditbalanceof$310,000atDecember31,priortothe
adjustingentryprocess.Thestraightlinemethodofdepreciationisused.
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LO49
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4. ManagementsignedanagreementtoletBoyScoutTroop538ofLewisburg,
Pennsylvania,usethecampgroundinJuneofnextyear.Theagreementspecifies
thattheBoyScoutswillpayadailyrateof$15percampsite,withaclause
providingaminimumtotalchargeof$1,475.
5. Salariesearnedbycampgroundemployeesthathavenotyetbeenpaidamountto
$1,250.
6. AsofDecember31,EnchantedForesthasearned$2,400ofrevenuefromcurrent
camperswhowillnotbebilleduntiltheycheckout.(DebitCamperRevenue
Receivable.)
7. Severallakefrontcampsitesarecurrentlybeingleasedonalongtermbasisbya
groupofseniorcitizens.Sixmonths'rentof$5,400wascollectedinadvanceand
creditedtoUnearnedCamperRevenueonOctober1ofthecurrentyear.
8. Abustocarrycamperstoandfromtownandtheairporthadbeenrentedthefirst
weekofDecemberatadailyrateof$40.AtDecember31,norentalpaymenthas
beenmade,althoughthecampgroundhashaduseofthebusfor25days.
Instructions
thesedescriptions,identifythetypeofeachadjustingentrypreparedinparta
above.
3. Indicatetheeffectsthateachoftheadjustmentsinpartawillhaveonthefollowing
sixtotalamountsinthecampground'sfinancialstatementsforthemonthof
December.Organizeyouranswerintabularform,usingthecolumnheadingsshown
below.UsethelettersIforincrease,Dfordecrease,andNEfornoeffect.
Adjustingentry1isprovidedasanexample.
IncomeStatement
BalanceSheet
AdjustingRevenueExpenses=NetIncomeAssets=Liabilities+Owners'Equity
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NE
NE
Page175
4. Whatistheamountofinterestexpenserecognizedfortheentirecurrentyearonthe
$12,000bankloanobtainedSeptember1?
5. Computethebookvalueofthecampground'sbuildingstobereportedinthecurrent
year'sDecember31balancesheet.(Refertoparagraph3.)
LO41
through
LO47,
LO49
GunflintAdventuresoperatesanairplaneservicethattakesfishingpartiestoaremotelake
resortinnorthernManitoba,Canada.Individualsmustpurchasetheirticketsatleastone
monthinadvanceduringthebusysummerseason.Thecompanyadjustsitsaccountsonly
onceeachmonth.Selectedbalancesappearinginthecompany'sJune30adjustedtrial
PROBLEM balanceappearasfollows:
4.3A
Analysisof
Adjusted
Data
LO41
through
LO47,
LO49
Debit Credit
Prepaidairportrent..................................... $9,000
Unexpiredinsurance....................................
Airplane.............................................
Accumulateddepreciation:airplane.........................
Unearnedpassengerrevenue.............................
4,200
288,000
$80,000
75,000
OtherInformation
1. Theairplaneisbeingdepreciatedovera15yearlifewithnoresidualvalue.
2. UnearnedpassengerrevenuerepresentsadvanceticketsalesforbookingsinJulyand
Augustat$300perticket.
3. Sixmonths'airportrenthadbeenprepaidonMay1.
4. Theunexpiredinsuranceiswhatremainsofa12monthpolicypurchasedon
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February1.
5. PassengerrevenueearnedinJunetotaled$40,000.
Instructions
1. Determinethefollowing:
1. Theageoftheairplaneinmonths.
2. Themonthlyairportrentexpense.
3. Theamountpaidforthe12monthinsurancepolicyonFebruary1.
2. PreparetheadjustingentriesmadeonJune30involvingthefollowingaccounts:
1. DepreciationExpense:Airplane
2. AirportRentExpense
3. InsuranceExpense
4. PassengerRevenueEarned
LO41
through
LO47,
LO49
CampusTheateradjustsitsaccountseverymonth.Thecompany'sunadjustedtrialbalance
datedAugust31,2015,isonpage176.Additionalinformationisprovidedforusein
preparingthecompany'sadjustingentriesforthemonthofAugust.(Bearinmindthat
adjustingentrieshavealreadybeenmadeforthefirstsevenmonthsof2015,butnotfor
PROBLEM August.)
4.4A
Preparing
Adjusting
Entries
fromaTrial
Balance
LO41
through
LO47,
LO49
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CAMPUSTHEATER
AUGUST31,2015
Cash....................................................................................
$20,000
Prepaidfilmrental................................................................
31,200
Land....................................................................................
120,000
Building...............................................................................
168,000
Accumulateddepreciation:building......................................
Fixturesandequipment........................................................
$14,000
36,000
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Accumulateddepreciation:fixturesandequipment...............
12,000
Notespayable......................................................................
180,000
Accountspayable................................................................
4,400
Unearnedadmissionsrevenue(YMCA).................................
1,000
Incometaxespayable..........................................................
4,740
Capitalstock........................................................................
40,000
Retainedearnings................................................................
46,610
Dividends.............................................................................
15,000
Admissionsrevenue.............................................................
305,200
Concessionsrevenue...........................................................
14,350
Salariesexpense..................................................................
68,500
Filmrentalexpense..............................................................
94,500
Utilitiesexpense...................................................................
9,500
Depreciationexpense:building.............................................
4,900
Depreciationexpense:fixturesandequipment......................
4,200
Interestexpense..................................................................
10,500
Incometaxesexpense.........................................................
40,000
$622,300$622,300
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Page176
OtherData
1. Filmrentalexpenseforthemonthis$15,200.However,thefilmrentalexpensefor
severalmonthshasbeenpaidinadvance.
2. Thebuildingisbeingdepreciatedoveraperiodof20years(240months).
3. Thefixturesandequipmentarebeingdepreciatedoveraperiodoffiveyears(60
months).
4. Onthefirstofeachmonth,thetheaterpaystheinterestthataccruedintheprior
monthonitsnotepayable.AtAugust31,accruedinterestpayableonthisnote
amountsto$1,500.
5. ThetheaterallowsthelocalYMCAtobringchildrenattendingsummercamptothe
moviesonanyweekdayafternoonforafixedfeeof$500permonth.OnJune28,the
YMCAmadea$1,500advancepaymentcoveringthemonthsofJuly,August,and
September.
6. ThetheaterreceivesapercentageoftherevenueearnedbyTastieCorporation,the
concessionaireoperatingthesnackbar.ForsnackbarsalesinAugust,Tastieowes
CampusTheater$2,250,payableonSeptember10.Noentryhasyetbeenmadeto
recordthisrevenue.(CreditConcessionsRevenue.)
7. Salariesearnedbyemployees,butnotrecordedorpaidasofAugust31,amountto
$1,700.Noentryhasyetbeenmadetorecordthisliabilityandexpense.
8. IncometaxesexpenseforAugustisestimatedat$4,200.Thisamountwillbepaidin
theSeptember15installmentpayment.
9. Utilitiesexpenseisrecordedasmonthlybillsarereceived.Noadjustingentriesfor
utilitiesexpensearemadeatmonthend.
Page177
Instructions
1. Foreachofthenumberedparagraphs,preparethenecessaryadjustingentry
(includinganexplanation).
2. RefertothebalancesshownintheunadjustedtrialbalanceatAugust31.Howmany
monthsofexpenseareincludedineachofthefollowingaccountbalances?
(Remember,CampusTheateradjustsitsaccountsmonthly.Thus,theaccountsshown
werelastadjustedonJuly31,2015.)
1. UtilitiesExpense
2. DepreciationExpense
3. AccumulatedDepreciation:Building
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3. Assumethetheaterhasbeenoperatingprofitablyallyear.AlthoughtheAugust31
trialbalanceshowssubstantialincometaxesexpense,incometaxespayableisa
muchsmalleramount.Thisrelationshipisquitenormalthroughoutmuchoftheyear.
Explain.
LO41
through
LO47,
LO49
TerrificTempsfillstemporaryemploymentpositionsforlocalbusinesses.Some
businessespayinadvanceforservicesothersarebilledafterserviceshavebeen
performed.AdvancedpaymentsarecreditedtoanaccountentitledUnearnedFees.
Adjustingentriesareperformedonamonthlybasis.Anunadjustedtrialbalancedated
PROBLEM December31,2015,follows.(Bearinmindthatadjustingentrieshavealreadybeenmade
4.5A
forthefirst11monthsof2015,butnotforDecember.)
Preparing
Adjusting
Entriesand
Determining
Account
Balances
LO41
through
LO47,
LO49
d
TERRIFICTEMPS
DECEMBER31,2015
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Cash.............................................
$27,020
Accountsreceivable.................................
59,200
Unexpiredinsurance.................................
900
Prepaidrent.......................................
3,000
Officesupplies.....................................
600
Equipment........................................
60,000
Accumulateddepreciation:equipment....................
$29,500
Accountspayable...................................
4,180
Notespayable......................................
12,000
Interestpayable....................................
320
Unearnedfees.....................................
6,000
Incometaxespayable................................
4,000
Unearnedrevenue...................................
20,000
Retainedearnings...................................
49,000
Capitalstock.......................................
25,000
Dividends.........................................
3,000
Feesearned.......................................
Travelexpense.....................................
75,000
5,000
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Insuranceexpense..................................
2,980
Rentexpense......................................
9,900
Officesuppliesexpense..............................
780
Utilitiesexpense....................................
4,800
Depreciationexpense:equipment.......................
5,500
Salariesexpense....................................
30,000
Interestexpense....................................
320
Incometaxesexpense...............................
12,000
$225,000$225,000
Page178
OtherData
1. AccruedbutunrecordedfeesearnedasofDecember31,2015,amountto$1,500.
2. Recordsshowthat$2,500ofcashreceiptsoriginallyrecordedasunearnedfeeshad
beenearnedasofDecember31.
3. ThecompanypurchasedasixmonthinsurancepolicyonSeptember1,2015,for
$1,800.
4. OnDecember1,2015,thecompanypaiditsrentthroughFebruary28,2016.
5. OfficesuppliesonhandatDecember31amountto$400.
6. Allequipmentwaspurchasedwhenthebusinessfirstformed.Theestimatedlifeof
theequipmentatthattimewas10years(or120months).
7. OnAugust1,2015,thecompanyborrowed$12,000bysigningasixmonth,8
percentnotepayable.Theentirenote,plussixmonths'accruedinterest,isdueon
February1,2016.
8. AccruedbutunrecordedsalariesatDecember31amountto$2,700.
9. Estimatedincometaxesexpensefortheentireyeartotals$15,000.Taxesareduein
thefirstquarterof2016.
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Instructions
2. Determinethatamountatwhicheachofthefollowingaccountswillbereportedin
thecompany's2015incomestatement:
1. FeesEarned
2. TravelExpense
3. InsuranceExpense
4. RentExpense
5. OfficeSuppliesExpense
6. UtilitiesExpense
7. DepreciationExpense:Equipment
8. InterestExpense
9. SalariesExpense
10. IncomeTaxesExpense
3. Theunadjustedtrialbalancereportsdividendsof$3,000.AsofDecember31,2015,
havethesedividendsbeenpaid?Explain.
LO41
through
LO47,
LO49
AlpineExpeditionsoperatesamountainclimbingschoolinColorado.Someclientspayin
advanceforservicesothersarebilledafterserviceshavebeenperformed.Advance
paymentsarecreditedtoanaccountentitledUnearnedClientRevenue.Adjustingentries
areperformedonamonthlybasis.AnunadjustedtrialbalancedatedDecember31,2015,
PROBLEM follows.(Bearinmindthatadjustingentrieshavealreadybeenmadeforthefirst11
4.6A
monthsof2015,butnotforDecember.)
Preparing Page179
Adjusting
Entriesand
Determining
Account
Balances
LO41
through
LO47,
LO49
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d
ALPINEEXPEDITIONS
DECEMBER31,2015
Cash............................................
$13,900
Accountsreceivable................................
78,000
Unexpiredinsurance................................
18,000
Prepaidadvertising.................................
2,200
Climbingsupplies..................................
4,900
Climbingequipment................................
57,600
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Accumulateddepreciation:climbingequipment............
$38,400
Accountspayable..................................
1,250
Notespayable.....................................
10,000
Interestpayable...................................
150
Incometaxespayable...............................
1,200
Unearnedclientrevenue.............................
9,600
Capitalstock......................................
17,000
Retainedearnings..................................
62,400
Clientrevenueearned..................................
188,000
Advertisingexpense................................
7,400
Insuranceexpense.................................
33,000
Rentexpense.....................................
16,500
Climbingsuppliesexpense...........................
8,400
Repairsexpense...................................
4,800
Depreciationexpense:climbingequipment...............
13,200
Salariesexpense...................................
57,200
Interestexpense...................................
150
Incometaxesexpense..............................
12,750
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$328,000$328,000
OtherData
1. AccruedbutunrecordedfeesearnedasofDecember31amountto$6,400.
2. Recordsshowthat$6,600ofcashreceiptsoriginallyrecordedasunearnedclient
revenuehadbeenearnedasofDecember31.
3. Thecompanypurchaseda12monthinsurancepolicyonJune1,2015,for$36,000.
4. OnDecember1,2015,thecompanypaid$2,200fornumerousadvertisementsin
severalclimbingmagazines.Halfoftheseadvertisementshaveappearedinprintas
ofDecember31.
5. suppliesonhandatDecember31amountto$2,000.
6. Allclimbingequipmentwaspurchasedwhenthebusinessfirstformed.The
estimatedlifeoftheequipmentatthattimewasfouryears(or48months).
7. OnOctober1,2015,thecompanyborrowed$10,000bysigninganeightmonth,9
percentnotepayable.Theentirenote,pluseightmonths'accruedinterest,isdueon
June1,2016.
Page180
Instructions
thecompany'sbalancesheetdatedDecember31,2015:
1. Cash
2. AccountsReceivable
3. UnexpiredInsurance
4. PrepaidAdvertising
5. ClimbingSupplies
6. ClimbingEquipment
7. AccumulatedDepreciation:ClimbingEquipment
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8. SalariesPayable
9. NotesPayable
10. InterestPayable
11. IncomeTaxesPayable
12. UnearnedClientRevenue
3. Whichoftheaccountslistedinpartbrepresentdeferredexpenses?Explain.
LO41
through
LO47,
LO49
KenHensleyEnterprises,Inc.,isasmallrecordingstudioinSt.Louis.Rockbandsusethe
studiotomixhighqualitydemorecordingsdistributedtotalentagents.Newclientsare
requiredtopayinadvanceforstudioservices.Bandswithestablishedcreditarebilledfor
studioservicesattheendofeachmonth.Adjustingentriesareperformedonamonthly
PROBLEM basis.AnunadjustedtrialbalancedatedDecember31,2015,follows.(Bearinmindthat
4.7A
adjustingentriesalreadyhavebeenmadeforthefirst11monthsof2015,butnotfor
December.)
Preparing
Adjusting
Entries
froma
Trial
Balance
LO41
through
LO47,
LO49
d
KENHENSLEYENTERPRISES,INC.
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DECEMBER31,2015
Cash....................................................$43,170
Accountsreceivable......................................
81,400
Studiosupplies...........................................
7,600
Unexpiredinsurance......................................
500
Prepaidstudiorent.......................................
4,000
Recordingequipment.....................................
90,000
Accumulateddepreciation:recordingequipment.............
$52,500
Notespayable............................................
16,000
Interestpayable..........................................
840
Incometaxespayable.....................................
3,200
Unearnedstudiorevenue.................................
9,600
Capitalstock............................................
80,000
Retainedearnings........................................
38,000
Studiorevenueearned....................................
107,000
Salariesexpense.........................................
18,000
Suppliesexpense........................................
1,200
Insuranceexpense........................................
2,680
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Depreciationexpense:recordingequipment.................
16,500
Studiorentexpense.......................................
21,000
Interestexpense.........................................
840
Utilitiesexpense.........................................
2,350
Incometaxesexpense....................................
17,900
$307,140$307,140
OtherData
1. Recordsshowthat$4,400instudiorevenuehadnotyetbeenbilledorrecordedasof
December31.
2. StudiosuppliesonhandatDecember31amountto$6,900.
Page181
3. OnAugust1,2015,thestudiopurchasedasixmonthinsurancepolicyfor$1,500.
TheentirepremiumwasinitiallydebitedtoUnexpiredInsurance.
4. Thestudioislocatedinarentedbuilding.OnNovember1,2015,thestudiopaid
$6,000rentinadvanceforNovember,December,andJanuary.Theentireamount
wasdebitedtoPrepaidStudioRent.
5. Theusefullifeofthestudio'srecordingequipmentisestimatedtobefiveyears(or60
months).Thestraightlinemethodofdepreciationisused.
6. OnMay1,2015,thestudioborrowed$16,000bysigninga12month,9percentnote
payabletoFirstFederalBankofSt.Louis.Theentire$16,000plus12months'
interestisdueinfullonApril30,2016.
7. Recordsshowthat$3,600ofcashreceiptsoriginallyrecordedasUnearnedStudio
RevenuehadbeenearnedasofDecember31.
8. SalariesearnedbyrecordingtechniciansthatremainunpaidatDecember31amount
to$540.
9. Thestudio'saccountantestimatesthatincometaxesexpensefortheentireyearended
December31,2015,is$19,600.(Notethat$17,900ofthisamounthasalreadybeen
recorded.)
Instructions
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2. Usingfiguresfromthecompany'sunadjustedtrialbalanceinconjunctionwiththe
adjustingentriesmadeinparta,computenetincomefortheyearendedDecember
31,2015.
3. Wasthestudio'smonthlyrentforthelast2monthsof2015moreorlessthanduring
thefirst10monthsoftheyear?Explainyouranswer.
4. Wasthestudio'smonthlyinsuranceexpenseforthelastfivemonthsof2015moreor
lessthantheaveragemonthlyexpenseforthefirstsevenmonthsoftheyear?Explain
youranswer.
5. Ifthestudiopurchasedallofitsequipmentwhenitfirstbeganoperations,forhow
manymonthshasitbeeninbusiness?Explainyouranswer.
6. Indicatetheeffectofeachadjustingentrypreparedinpartaonthemajorelementsof
thecompany'sincomestatementandbalancesheet.Organizeyouranswerintabular
formusingthecolumnheadingsshown.UsethesymbolsIforincrease,Dfor
decrease,andNEfornoeffect.Theanswerfortheadjustingentrynumber1is
providedasanexample.
IncomeStatement
BalanceSheet
1
NE
NE
LO41through
LO47,LO49 CoyneCorporationrecentlyhiredElaineHerroldasitsnewbookkeeper.Herroldwas
notveryexperiencedandmadesevenrecordingerrorsduringthelastaccounting
PROBLEM
period.Thenatureofeacherrorisdescribedinthefollowingtable.
4.8A
Instructions
Understanding
theEffectsof Indicatetheeffectofthefollowingerrorsoneachofthefinancialstatementelements
VariousErrors describedinthecolumnheadingsinthetableonpage182.Usethefollowingsymbols:
O=overstated,U=understated,andNE=noeffect.
LO41through
LO47,LO49 Page182
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Error
Total
Total
Net Total Total Owners'
RevenueExpensesIncomeAssetsLiabilities Equity
a.Recordedadividendasan
expensereportedintheincome
statement.
b.Recordedthepaymentofan
accountpayableasadebitto
accountspayableandacredittoan
expenseaccount.
c.Failedtorecorddepreciation
expense.
d.Recordedthesaleofcapital
stockasadebittocashandacredit
toretainedearnings.
e.Recordedthereceiptofa
customerdepositasadebittocash
andacredittofeesearned.
f.Failedtorecordexpiredportion
ofaninsurancepolicy.
g.Failedtorecordaccruedinterest
earnedonanoutstandingnote
receivable.
ProblemSetB
LO41
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throught
LO47
TheGeorgiaGunClubadjustsitsaccountsmonthlyandclosesitsaccountsannually.Club
memberspaytheirannualduesinadvancebyJanuary4.Theentireamountisinitially
creditedtoUnearnedMembershipDues.Attheendofeachmonth,anappropriateportion
PROBLEM ofthisamountiscreditedtoMembershipDuesEarned.Guestsoftheclubnormallypay
4.1B
theirfeesbeforebeingallowedtousethefacilities.Theamountscollectedarecreditedto
GuestFeeRevenueatthetimeofreceipt.Certainguests,however,arebilledattheendof
Preparing themonth.Thefollowinginformationisavailableasasourceforpreparingadjustingentries
Adjusting atDecember31:
Entries
1. Salariesearnedbytheclub'semployeesthathavenotyetbeenrecordedorpaid
LO41
amountto$13,600.
throught
LO47
2. TheGeorgiaStatePoliceusedtheclub'sfacilitiesfortargetpracticeonDecember30
ofthecurrentyear.AtDecember31,the$3,200owedbythestatepoliceforguest
feeshadnotyetbeenrecordedorbilled.
3. MembershipduesearnedinDecember,forcollectionsreceivedatthebeginningof
theyear,amountto$140,000.
4. Depreciationofthefurnitureandfixturesintheclubhouseisbasedonanestimated
lifeofeightyears.Theseitemshadoriginallybeenpurchasedfor$120,000.The
straightlinemethodisused.
(Note:Theclubhousebuildingwasconstructedin1956andisfullydepreciated.)
5. A12monthbankloanintheamountof$60,000hadbeenobtainedbytheclubon
October4.Interestiscomputedatanannualrateof8percent.Theentire$60,000,
plusalloftheinterestaccruedoverthe12monthlifeoftheloan,isdueinfullon
September30oftheupcomingyear.Thenecessaryadjustingentrywasmadeon
November30torecordthefirsttwomonthsofaccruedinterestexpense.However,no
adjustmenthasbeenmadetorecordinterestexpenseaccruedinDecember.
6. AoneyearpropertyinsurancepolicyhadbeenpurchasedonApril30.Theentire
premiumof$10,800wasinitiallyrecordedasUnexpiredInsurance.
7. InDecember,theclubenteredintoanagreementtohosttheannualtournamentofthe
GeorgiaJuniorRifleAssociation.Theclubexpectstogenerateguestfeesof$7,200
fromthisevent.
Instructions
Page183
thesedescriptions,identifythetypeofeachadjustingentrypreparedinpartaabove.
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3. Althoughtheclubhousebuildingisfullydepreciated,itisinexcellentphysical
condition.Explainhowthiscanbe.
LO41
through
LO46,
LO49
PROBLEM
4.2B
Preparing
and
Analyzing
theEffectsof
Adjusting
Entries
LO41
through
LO46,
LO49
BigOaks,alargecampgroundinVermont,adjustsitsaccountsmonthlyandclosesits
accountsannuallyonDecember31.Mostguestsofthecampgroundpayatthetimethey
checkout,andtheamountscollectedarecreditedtoCamperRevenue.Thefollowing
informationisavailableasasourceforpreparingtheadjustingentriesatDecember31:
1. BigOaksinvestssomeofitsexcesscashincertificatesofdeposit(CDs)withits
localbank.AccruedinterestrevenueonitsCDsatDecember31is$425.Noneof
theinteresthasyetbeenreceived.(DebitInterestReceivable.)
2. Aneightmonthbankloanintheamountof$12,000hadbeenobtainedonOctober
1.Interestistobecomputedatanannualrateof8percentandispayablewhenthe
loanbecomesdue.
3. Depreciationonbuildingsownedbythecampgroundisbasedona20yearlife.The
originalcostofthebuildingswas$720,000.TheAccumulatedDepreciation:
Buildingsaccounthasacreditbalanceof$160,000atDecember31,priortothe
adjustingentryprocess.Thestraightlinemethodofdepreciationisused.
4. ManagementsignedanagreementtoletGirlScoutsfromEaston,Connecticut,use
thecampgroundinJuneofnextyear.TheagreementspecifiesthattheGirlScouts
willpayadailyrateof$15percampsite,withaclauseprovidingaminimumtotal
chargeof$1,200.
5. Salariesearnedbycampgroundemployeesthathavenotyetbeenpaidamountto
$1,515.
6. AsofDecember31,BigOakshasearned$2,700ofrevenuefromcurrentcampers
whowillnotbebilleduntiltheycheckout.(DebitCamperRevenueReceivable.)
7. Severallakefrontcampsitesarecurrentlybeingleasedonalongtermbasisbya
groupofseniorcitizens.Fivemonths'rentof$7,500wascollectedinadvanceand
creditedtoUnearnedCamperRevenueonNovember1ofthecurrentyear.
8. Abustocarrycamperstoandfromtownandtheairporthadbeenrentedthefirst
weekofDecemberatadailyrateof$45.AtDecember31,norentalpaymenthas
beenmade,althoughthecampgroundhashaduseofthebusfor18days.
Instructions
thesedescriptions,identifythetypeofeachadjustingentrypreparedinparta
above.
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3. Indicatetheeffectsthateachoftheadjustmentsinpartawillhaveonthefollowing
sixtotalamountsinthecampground'sfinancialstatementsforthemonthof
December.Organizeyouranswerintabularform,usingthecolumnheadingsshown
below.UsethelettersIforincrease,Dfordecrease,andNEfornoeffect.
Adjustingentry1isprovidedasanexample.
IncomeStatement
Adjusting
Entry
1
RevenueExpenses=
NE
BalanceSheet
Net
Assets=Liabilities+
Income
I
Owners'
Equity
NE
4. Whatistheamountofinterestexpenserecognizedfortheentirecurrentyearonthe
$12,000bankloanobtainedOctober1?
5. Computethebookvalueofthecampground'sbuildingstobereportedinthecurrent
year'sDecember31balancesheet.(Refertoparagraph3.)
LO41
through
LO47,
LO49
RiverRat,Inc.,operatesaferrythattakestravelersacrosstheWildRiver.Thecompany
adjustsitsaccountsattheendofeachmonth.Selectedaccountbalancesappearinginthe
April30adjustedtrialbalanceareasfollows:
PROBLEM
4.3B
Analysisof
Adjusted
Data
LO41
through
LO47,
LO49
Debit Credit
Prepaidrent................................................. $18,000
Unexpiredinsurance.........................................
3,800
Ferry....................................................... 93,600
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Accumulateddepreciation:ferry...............................
Unearnedpassengerrevenue.................................
$16,900
1,000
OtherData
Page184
1. Theferryisbeingdepreciatedoveran12yearestimatedusefullife.
2. Theunearnedpassengerrevenuerepresentsticketsgoodforfutureridessoldtoa
resorthotelfor$5perticketonApril1.DuringApril,150oftheticketswereused.
3. Sixmonths'renthadbeenprepaidonApril1.
4. Theunexpiredinsuranceisa12monthfireinsurancepolicypurchasedonMarch1.
Instructions
1. Determinethefollowing:
1. Theageoftheferryinmonths.
2. Howmany$5ticketsforfutureridesweresoldtotheresorthotelonApril1.
3. Themonthlyrentexpense.
4. Theoriginalcostofthe12monthfireinsurancepolicy.
2. PreparetheadjustingentriesthatweremadeonApril30.
LO41
through
LO47,
LO49
TheOffCampusPlayhouseadjustsitsaccountseverymonth.Belowisthecompany's
unadjustedtrialbalancedatedSeptember30,2015.Additionalinformationisprovidedfor
useinpreparingthecompany'sadjustingentriesforthemonthofSeptember.(Bearinmind
thatadjustingentrieshavealreadybeenmadeforthefirsteightmonthsof2015,butnotfor
PROBLEM September.)
4.4B
Preparing
Adjusting
Entries
froma
Trial
Balance
LO41
through
LO47,
LO49
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d
OFFCAMPUSPLAYHOUSE
SEPTEMBER30,2015
Cash................................................. $8,200
Prepaidcostumerental...................................
1,800
Land.................................................
80,000
Building............................................... 150,000
Accumulateddepreciation:building.........................
Fixturesandequipment...................................
Accumulateddepreciation:fixturesandequipment.............
$18,500
18,000
4,500
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Notespayable..........................................
100,000
Accountspayable.......................................
5,700
Unearnedadmissionsrevenue(nursinghomes)................
1,500
Incometaxespayable....................................
4,700
Capitalstock...........................................
9,000
Retainedearnings.......................................
26,400
Dividends..............................................
9,000
Admissionsrevenue.....................................
180,200
Concessionsrevenue....................................
19,600
Salariesexpense........................................
57,400
Costumerentalexpense..................................
2,700
Utilitiesexpense........................................
7,100
Depreciationexpense:building.............................
4,000
Depreciationexpense:fixturesandequipment.................
2,400
Interestexpense........................................
8,500
Incometaxesexpense................................... 21,000
$370,100$370,100
OtherData
Page185
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1. Costumerentalexpenseforthemonthis$600.However,thecostumerentalexpense
forseveralmonthshasbeenpaidinadvance.
2. Thebuildingisbeingdepreciatedoveraperiodof25years(300months).
3. Thefixturesandequipmentarebeingdepreciatedoveraperiodoffiveyears(60
months).
4. Onthefirstofeachmonth,thetheaterpaystheinterestwhichaccruedintheprior
monthonitsnotepayable.AtSeptember30,accruedinterestpayableonthisnote
amountsto$1,062.
5. Theplayhouseallowslocalnursinghomestobringseniorstotheplaysonany
weekdayperformanceforafixedpriceof$500permonth.OnAugust31,anursing
homemadea$1,500advancepaymentcoveringthemonthsofSeptember,October,
andNovember.
6. ThetheaterreceivesapercentageoftherevenueearnedbySweetCorporation,the
concessionaireoperatingthesnackbar.ForsnackbarsalesinSeptember,Sweetowes
OffCampusPlayhouse$4,600,payableonOctober14.Noentryhasyetbeenmade
torecordthisrevenue.(CreditConcessionsRevenue.)
7. Salariesearnedbyemployees,butnotrecordedorpaidasofSeptember30,amountto
$2,200.Noentryhasyetbeenmadetorecordthisliabilityandexpense.
8. IncometaxesexpenseforSeptemberisestimatedat$3,600.Thisamountwillbepaid
intheOctober15installmentpayment.
9. Utilitiesexpenseisrecordedasmonthlybillsarereceived.Noadjustingentriesfor
utilitiesexpensearemadeatmonthend.
Instructions
2. RefertothebalancesshownintheunadjustedtrialbalanceatSeptember30.How
manymonthsofexpenseareincludedineachofthefollowingbalances?(Remember,
OffCampusPlayhouseadjustsitsaccountsmonthly.Thus,theaccountsshownwere
lastadjustedonAugust31,2015.)
1. Utilitiesexpense
2. Depreciationexpense
3. Accumulateddepreciation:building
3. Assumetheplayhousehasbeenoperatingprofitablyallyear.AlthoughtheSeptember
30trialbalanceshowssubstantialincometaxesexpense,incometaxespayableisa
muchsmalleramount.Thisrelationshipisquitenormalthroughoutmuchoftheyear.
Explain.
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LO41
through
LO47,
LO49
MarvelousMusicprovidesmusiclessonstostudentmusicians.Somestudentspayin
advanceforlessonsothersarebilledafterlessonshavebeenprovided.Advancepayments
arecreditedtoanaccountentitledUnearnedLessonRevenue.Adjustingentriesare
performedonamonthlybasis.AnunadjustedtrialbalancedatedDecember31,2015,
follows.(Bearinmindthatadjustingentrieshavealreadybeenmadeforthefirst11
PROBLEM monthsof2015,butnotforDecember.)
4.5B
Page186
Preparing
Adjusting
Entriesand
Determining
Account
Balances
LO41
through
LO47,
LO49
d
MARVELOUSMUSIC
DECEMBER31,2015
Cash............................................... $15,800
Accountsreceivable...................................
2,100
Unexpiredinsurance...................................
3,200
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Prepaidrent..........................................
Sheetmusicsupplies..................................
6,000
450
Musicequipment...................................... 180,000
Accumulateddepreciation:musicequipment................
$72,000
Accountspayable.....................................
3,500
Notespayable........................................
5,000
Dividendspayable.....................................
1,000
Interestpayable.......................................
25
Incometaxespayable..................................
3,400
Unearnedlessonrevenue...............................
1,100
Capitalstock.........................................
20,000
Retainedearnings.....................................
56,600
Dividends............................................
1,000
Lessonrevenueearned.................................
154,375
Advertisingexpense...................................
7,400
Insuranceexpense....................................
4,400
Rentexpense........................................
16,500
Sheetmusicsuppliesexpense...........................
780
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Utilitiesexpense......................................
5,000
Depreciationexpense:musicequipment...................
33,000
Salariesexpense......................................
27,500
Interestexpense......................................
25
Incometaxesexpense................................. 13,845
$317,000$317,000
OtherData
1. AccruedbutunrecordedlessonrevenueearnedasofDecember31,2015,amountsto
$3,200.
2. Recordsshowthat$800ofcashreceiptsoriginallyrecordedasunearnedlesson
revenuehadbeenearnedasofDecember31.
3. Thecompanypurchaseda12monthinsurancepolicyonAugust1,2015,for$4,800.
4. OnOctober1,2015,thecompanypaid$9,000forrentthroughMarch31,2016.
5. SheetmusicsuppliesonhandatDecember31amountto$200.
6. Allmusicequipmentwaspurchasedwhenthebusinesswasfirstformed.Its
estimatedlifeatthattimewasfiveyears(or60months).
7. OnNovember1,2015,thecompanyborrowed$5,000bysigningathreemonth,6
percentnotepayable.Theentirenote,plusthreemonths'accruedinterest,isdueon
February1,2016.
Instructions
Page187
thecompany's2015incomestatement:
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1. LessonRevenueEarned
2. AdvertisingExpense
3. InsuranceExpense
4. RentExpense
5. SheetMusicSuppliesExpense
6. UtilitiesExpense
7. DepreciationExpense:MusicEquipment
8. InterestExpense
9. SalariesExpense
10. IncomeTaxesExpense
3. Theunadjustedtrialbalancereportsdividendsof$1,000.AsofDecember31,2015,
havethesedividendsbeenpaid?Explain.
LO41
MateEaseisanInternetdatingservice.Allmemberspayinadvancetobelistedinthe
through
LO47,LO4 database.AdvancepaymentsarecreditedtoanaccountentitledUnearnedMemberDues.
9
December31,2015,follows.(Bearinmindthatadjustingentrieshavealreadybeenmade
PROBLEM forthefirst11monthsof2015,butnotforDecember.)
4.6B
Preparing
Adjusting
Entriesand
Determining
Account
Balances
LO41
through
LO47,LO4
9
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d
MATEEASE
DECEMBER31,2015
Cash................................................ $169,500
Unexpiredinsurance....................................
12,800
Prepaidrent...........................................
14,600
Officesupplies.........................................
2,160
Computerequipment...................................
108,000
Accumulateddepreciation:computerequipment..............
$54,000
Accountspayable......................................
4,300
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Notespayable.........................................
90,000
Interestpayable........................................
6,750
Incometaxespayable...................................
7,500
Unearnedmemberdues.................................
36,000
Capitalstock..........................................
40,000
Retainedearnings......................................
28,000
Clientfeesearned......................................
508,450
Advertisingexpense....................................
17,290
Insuranceexpense.....................................
35,200
Rentexpense.........................................
80,300
Officesuppliesexpense.................................
18,400
Internetconnectionexpense..............................
24,000
Depreciationexpense:computerequipment.................
33,000
Salariesexpense.......................................
239,000
Interestexpense.......................................
6,750
Incometaxesexpense.................................. 14,000
$775,000$775,000
Page188
OtherData
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1. Recordsshowthat$21,000ofcashreceiptsoriginallyrecordedasunearned
memberdueshadbeenearnedasofDecember31,2015.
2. ThecompanypurchasedasixmonthinsurancepolicyonOctober1,2015,for
$19,200.
3. OnNovember1,2015,thecompanypaid$21,900forrentthroughJanuary31,
2016.
5. Allcomputerequipmentwaspurchasedwhenthebusinessfirstformed.The
estimatedlifeoftheequipmentatthattimewasthreeyears(or36months).
6. OnMarch1,2015,thecompanyborrowed$90,000bysigninga12month,10
percentnotepayable.Theentirenote,plus12months'accruedinterest,isdueon
March1,2016.
Instructions
thecompany'sbalancesheetdatedDecember31,2015:
1. Cash
2. UnexpiredInsurance
3. PrepaidRent
4. OfficeSupplies
5. ComputerEquipment
6. AccumulatedDepreciation:ComputerEquipment
7. AccountsPayable
8. NotesPayable
9. SalariesPayable
10. InterestPayable
11. IncomeTaxesPayable
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12. UnearnedMemberDues
3. Whydoesn'tthecompanyimmediatelyrecordadvancepaymentsfromcustomersas
revenue?
LO41
through
LO47,
LO49
ClintStillmoreoperatesaprivateinvestigatingagencycalledStillmoreInvestigations.
Someclientspayinadvanceforservicesothersarebilledafterserviceshavebeen
performed.AdvancepaymentsarecreditedtoanaccountentitledUnearnedRetainerFees.
PROBLEM December31,2015,follows.(Bearinmindthatadjustingentrieshavealreadybeenmade
4.7B
forthefirst11monthsof2015,butnotforDecember.)
Preparing
Adjusting
Entries
froma
Trial
Balance
LO41
through
LO47,
LO49
OtherData
1. AccruedbutunrecordedclientfeesearnedatDecember31amountto$1,500.
2. Recordsshowthat$2,500ofcashreceiptsoriginallyrecordedasUnearnedRetainer
FeeshadbeenearnedasofDecember31.
4. Thecompanypurchasedallofitsofficeequipmentwhenitfirstbeganbusiness.At
thattime,theequipment'sestimatedusefullifewassixyears(or72months).
5. OnOctober1,2015,thecompanyreneweditsrentalagreementpaying$1,800cash
forsixmonths'rentinadvance.
6. OnMarch1ofthecurrentyear,thecompanypaid$1,080cashtorenewits12month
insurancepolicy.
8. OnJune1,2015,thecompanyborrowedmoneyfromthebankbysigninga$9,000,8
percent,12monthnotepayable.Theentirenote,plus12months'accruedinterest,is
dueonMay31,2016.
9. Thecompany'sCPAestimatesthatincometaxesexpensefortheentireyearis
$7,500.
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d
STILLMOREINVESTIGATIONS
DECEMBER31,2015
Cash............................................... $40,585
Accountsreceivable...................................
2,000
Officesupplies........................................
205
Prepaidrent..........................................
1,200
Unexpiredinsurance...................................
270
Officeequipment......................................
54,000
Accumulateddepreciation:officeequipment................
$35,250
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Accountspayable.....................................
1,400
Interestpayable.......................................
360
Incometaxespayable..................................
1,750
Notepayable.........................................
9,000
Unearnedretainerfees.................................
3,500
Capitalstock.........................................
30,000
Retainedearnings.....................................
8,000
Dividends............................................
1,000
Clientfeesearned.....................................
Officesuppliesexpense................................
60,000
605
Depreciationexpense:officeequipment....................
8,250
Rentexpense........................................
5,775
Insuranceexpense....................................
1,010
Salariesexpense......................................
27,100
Interestexpense......................................
360
Incometaxesexpense................................. 6,900
Totals............................................. $149,260$149,260
Instructions
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2. Preparethecompany'sadjustedtrialbalancedatedDecember31,2015.
3. Usingfiguresfromtheadjustedtrialbalancepreparedinb,computenetincomefor
theyearendedDecember31,2015.
4. Howmuchwasthecompany'saveragemonthlyrentexpenseinJanuarythrough
Septemberof2015?Explainyouranswer.
5. Howmuchwasthecompany'saveragemonthlyinsuranceexpenseinJanuaryand
Februaryof2015?Explainyouranswer.
6. Ifthecompanypurchasedallofitsofficeequipmentwhenitfirstbeganoperations,
forhowmanymonthshasitbeeninbusiness?Explainyouranswer.
7. Indicatetheeffectofeachadjustingentrypreparedinpartaonthemajorelementsof
thecompany'sincomestatementandbalancesheet.Organizeyouranswerintabular
formusingthecolumnheadingsshown.UsethesymbolsIforincrease,Dfor
decrease,andNEfornoeffect.Theanswerforadjustingentrynumber1isprovided
asanexample.
IncomeStatement
BalanceSheet
1
NE
NE
Page190
LO41through
LO47,LO49 StephenCorporationrecentlyhiredTomWatersasitsnewbookkeeper.Watersisvery
inexperiencedandhasmadesevenrecordingerrorsduringthelastaccountingperiod.
PROBLEM
Thenatureofeacherrorisdescribedinthefollowingtable.
4.8B
Instructions
Understanding
theEffectsof Indicatetheeffectofthefollowingerrorsoneachofthefinancialstatementelements
VariousErrors describedinthecolumnheadingsinthetable.Usethefollowingsymbols:O=
overstated,U=understated,andNE=noeffect
LO41through
LO47,LO49
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Error
Total Total
Net
Total Total
Owners'
RevenueExpenses IncomeAssetsLiabilities Equity
a.Recordedadeclaredbut
unpaiddividendbydebiting
dividendsandcreditingcash.
b.Recordedareceiptofan
accountreceivableasadebitto
cashandacredittofeesearned.
c.Recordeddepreciation
expensetwice.
d.Recordedthesaleofcapital
stockasadebittocashanda
credittorevenue.
e.Purchasedequipmentand
debitedsuppliesexpenseand
creditedcash.
f.Failedtorecordexpired
portionofprepaidadvertising.
g.Failedtorecordaccruedand
unpaidinterestexpense.
CriticalThinkingCases
LO41
through PropertyManagementProfessionalsprovidesbuildingmanagementservicestoownersof
officebuildingsandshoppingcenters.Thecompanyclosesitsaccountsattheendofthe
LO47
calendaryear.Themannerinwhichthecompanyhasrecordedseveraltransactionsoccurring
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CASE4.1 during2015isdescribedasfollows:
Should
ThisBe
Adjusted?
1. OnSeptember1,receivedadvancepaymentfromashoppingcenterforproperty
managementservicestobeperformedoverthethreemonthperiodbeginning
September1.Theentireamountreceivedwascrediteddirectlytoarevenueaccount.
LO41
through
LO47
2. OnDecember1,receivedadvancepaymentfromthesamecustomerdescribedinparta
forservicestoberenderedoverthethreemonthperiodbeginningDecember1.This
time,theentireamountreceivedwascreditedtoanunearnedrevenueaccount.
3. RenderedmanagementservicesformanycustomersinDecember.Normalprocedureis
torecordrevenueonthedatethecustomerisbilled,whichisearlyinthemonthafter
theserviceshavebeenrendered.
4. OnDecember15,madefullpaymentforaoneyearinsurancepolicythatgoesinto
effectonJanuary2,2016.ThecostofthepolicywasdebitedtoUnexpiredInsurance.
5. Numerouspurchasesofequipmentweredebitedtoassetaccounts,ratherthanto
expenseaccounts.
6. Payrollexpenseisrecordedwhenemployeesarepaid.Paydayforthelasttwoweeksof
DecemberfallsonJanuary2,2016.
Instructions
Foreachitemabove,explainwhetheranadjustingentryisneededatDecember31,2015,and
statethereasonsforyouranswer.Ifyourecommendanadjustingentry,explaintheeffects
thisentrywouldhaveonassets,liabilities,owners'equity,revenue,andexpensesinthe2015
financialstatements.
Page191
LO48
Theconceptofmaterialityisoneofthemostbasicprinciplesunderlyingfinancial
CASE4.2 accounting.
The
Conceptof
Materiality
LO48
1. Answerthefollowingquestions:
1. Whyisthematerialityofatransactionoraneventamatterofprofessional
judgment?
2. Whatcriteriashouldaccountantsconsiderindeterminingwhetheratransaction
oraneventismaterial?
3. Doestheconceptofmaterialitymeanthatfinancialstatementsarenotprecise,
downtothelastdollar?Doesthisconceptmakefinancialstatementslessuseful
tomostusers?
2. AvisRentaCarpurchasesalargenumberofcarseachyearforitsrentalfleet.The
costofanyindividualautomobileisimmaterialtoAvis,whichisaverylarge
corporation.WoulditbeacceptableforAvistochargethepurchaseofautomobiles
foritsrentalfleetdirectlytoexpense,ratherthantoanassetaccount?Explain.
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LO43,
LO47,
LO48
CASE4.3
IEBWireframe
SlipperySlope,Inc.,isadownhillskiareainnorthernNewEngland.Inanattempttoattract
moreskienthusiasts,SlipperySlope'smanagementrecentlyengagedinanaggressive
preseasonadvertisingcampaigninwhichitspent$9,000todistributebrochures,$17,000to
airbroadcastmediaspots,and$14,000torunmagazineandnewspaperads.
SlipperySlopeisnowplanningtoborrowmoneyfromalocalbanktoexpandits
Holdthe snowmakingcapabilitiesnextseason.Inpreparingfinancialstatementstobeusedbythe
Expenses! bank,SlipperySlope'smanagementcapitalizedtheentire$40,000ofadvertisingexpenditures
asPrepaidAdvertisinginthecurrentyear'sbalancesheet.Itdecidedtodeferconvertingthis
LO43, assettoadvertisingexpenseforthreeyears,arguingthatitwilltakealeastthatlongtorealize
LO47, thefullbenefitofitspromotionalefforts.Managementalsocontendsthatitdoesnotmatter
LO48
howthe$40,000advertisingexpenditureisreported,becausetheamountisimmaterial.
Instructions
1. Doesmanagement'sdecisiontodeferconvertingthis$40,000prepaymentto
advertisingexpensecomplywithgenerallyacceptedaccountingprinciples?Defend
youranswer.
2. Couldmanagement'sdecisiontodeferreportingthisexpenditureasanexpensefor
threeyearshaveanyethicalimplications?Explain.
LO41
throughLO4 VisitHershey'shomepageat:
6
www.hersheys.com
INTERNET
FromHershey'shomepage,accessitsmostrecentannualreport(followCorporate
CASE4.4
InformationtotheInvestorRelationslink).Examinethecompany'sbalancesheet
andidentifytheaccountsmostlikelytohavebeeninvolvedintheendofyearadjusting
Identifying
entryprocess.
Accounts
Requiring
Internetsitesaretimeanddatesensitive.Itisthepurposeoftheseexercisestohaveyou
Adjusting
exploretheInternet.YoumayneedtousetheYahoo!searchenginewww.yahoo.com
Entries
(oranotherfavoritesearchengine)tofindacompany'scurrentwebaddress.
LO41
throughLO4
6
AnswerstoSelfTestQuestions
1. c
2. d,$11,670($27,900$17,340$2,700$1,440+$3,300+$1,950)
3. d
4. b,c
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5. b,c,d
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Footnotes
1Afifthcategoryofadjustingentriesconsistsofadjustmentsrelatedtothevaluationofcertainassets,
suchasmarketablesecuritiesandaccountsreceivable.Thesevaluationadjustmentsareexplainedand
illustratedinChapter7.
2Atthispointinourdiscussion,weareignoringanypossibleresidualvaluethatmightberecovered
upondisposaloftheasset.ResidualvaluesarediscussedinChapter9.WewillassumethatOvernight
AutoServicedepreciatesitsassetsusingthestraightlinemethodcomputedwithoutanyresidualvalues.
3Cost,$12,000,lessaccumulateddepreciation,whichamountsto$2,200aftertheDecember31
adjustingentry.
4Inthepreparationofaformalpayroll,wagesandpayrolltaxesmustbecomputeddowntothelast
cent.Butthisisnotapayrollitisanamounttobeusedinthecompany'sfinancialstatements.
Therefore,areasonableestimatewillsuffice.Theaccountingprincipleofmaterialityisdiscussedlaterin
thischapter.
5Inthisillustration,wedonotaddressthedetailsassociatedwithpayrolltaxesandamountswithheld.
ThesetopicsarediscussedinChapter10.
6ThisassumptionenablesustoaccrueincometaxesinDecemberinthesamemannerasinother
months.Otherwise,incometaxesforthismonthwouldberecordedasamidmonthtransaction,rather
thaninanendofmonthadjustingentry.Theadjustingentryforincometaxesisanexampleofan
accrued,butunpaid,expense.
7Taxrefundsmaybelimitedtotaxpaymentsinrecentyears.Inthisintroductorydiscussion,weassume
thecompanyhaspaidsufficienttaxesinprioryearstopermitafullrecoveryofanynegativetax
expenserelatingtothelossinthecurrentperiod.
8ThispointisemphasizedbythefactthatGeneralElectricroundsthedollaramountsshowninits
financialstatementstothenearest$1million.Thisroundingoffinancialstatementamountsis,initself,
anapplicationofthematerialityconcept.
9ThebalanceintheRetainedEarningsaccountwillbebroughtuptodateduringtheclosingprocess,
discussedinChapter5.
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RevenueExpensesNetIncome Assets LiabilitiesOwners'Equity

Increase Noeffect Increase

Increase Noeffect Increase

Increase Noeffect Increase

$210,000 $210,000$218,750 $218,750

EXERCISE TypeI ConvertingAssetstoExpenses

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