Chapter 3 - Adjusting Entries

3131 Intermediate Financial Accounting I

PROBLEM #1 The following information relates to the Airflame Company at the end of 2007. They sell merchandise and magazine subscriptions. The accounting period is the calendar year. This is the company's first year of operations. 1. Employees are paid every Friday for the five-day work week ending on that day. Salaries amount to $2,400 per week. The accounting period ends on a Wednesday. On October 1,2007, Airflame borrowed $8,000 cash by signing a note payable due in one year at 8% interest. Interest is due when the principal is paid. A note for $2,000 was received from a customer in a sales transaction on May 1, 2007. The note matures in one year and bears 12% interest per annum. Interest is due when the principal is due. A portion of Airflame's parking lot is used by executives of a neighboring company. A person pays $6 per day for each day's use, and the parking fees are due by the fifth business day following the month of use. The fees for December 31, 2007 amount to $1,260. On July 1, 2007, cash of $48,000 was received from subscribers (customers) for a 36-month subscription period beginning on that date. The receipt was recorded by a debit to Cash and a credit to Unearned Subscription Revenue. The Office Supplies on Hand account showed a balance of $3,500 at the beginning of 2007. Supplies costing $12,000 were purchased during 2007 and debited to the asset account. Supplies of $2,200 were on hand at December 31,2007. An insurance premium of $8,000 was paid on April 1, 2007, and was charged to Prepaid Insurance. The premium covers a 24-month period beginning April 1, 2007.

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Using the information given above, prepare the necessary adjusting entries at December 31, 2007.

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PROBLEM #2 This exercise will provide you with examples of adjusting entries for: Prepaid expenses when cash payments are recorded in an asset (real) account. Prepaid expenses when cash payments are recorded in an expense (nominal) account. Unearned revenues when cash receipts are recorded in a liability (real) account. Unearned revenues when cash receipts are recorded in a revenue (nominal) account. Thus, this exercise will review the alternative treatments of prepaid expenses and unearned revenues.Each situation described below is independent of the others. 1) Office supplies are recorded in an asset account when acquired. There were $400 of supplies on hand at the beginning of the period. Cash purchases of office supplies during the period amount to $900. A count of supplies at the end of the period shows $320 worth to be on hand. 2) Office supplies are recorded in an expense account when acquired. There were $400 of supplies on hand at the beginning of the period. Cash purchases of office supplies during the period amount to $900. A count of supplies at the end of the period shows $320 worth to be on hand. No reversing entries are used. 3) Receipts from customers for magazine subscriptions are recorded as a liability when cash is collected in advance of delivery. The beginning balance in the liability account was $6,700. During the period, $54,000 was received for subscriptions. At the end of the period, it was determined that the balance of the Unearned Subscription Revenue account should be $8,000. 4) Receipts from customers for magazine subscriptions are recorded as revenue when cash is collected in advance of delivery. The beginning balance in the liability account was $6,700. During the period, $54,000 was received for subscriptions. At the end of the period, it was determined that the balance of the Unearned Subscription Revenue account should be $8,000. No reversing entries are used. Instructions For each of the independent situations above: (a) Prepare the appropriate adjusting entry in general journal form. (b) Indicate the amount of revenue or expense which will appear on the income statement for the period. (c) Indicate the balance of the applicable asset or liability account at the end of the period. (d) Indicate the amount of cash received or paid during the period. (e) Indicate the change in the applicable asset or liability account from the beginning of the period to the end of the period.

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SOLUTIONS FOR PROBLEMS PROBLEM #1 Solutions: 1. Salaries Expense Salaries Payable (2,400 / 5 = $480); ($480 x 3 = $1,440) Interest Expense Interest Payable ($8000 x 8% x 3/12 = $160) 3. Interest Receivable Interest Revenue ($2,000 x 12% x 8/12 = $160) Parking Fees Receivable Parking Fees Revenue 2. DR 1440 CR 1440

160 160

160 160

4.

1260 1260 8000 8000

5. Unearned Subscription Revenue Subscription Revenue ($48,000 x 6/36 = $8,000 earned revenue) 6. Supplies Expense Office Supplies Inventory ($3,500 + $12,000 - $2,200 = $13,300) Insurance Expense Prepaid Insurance ($8,000 x 9/24 = $3,000 expired cost)

$13,300 13,300

7.

3000 3000

Approach and Explanation: Write down the definitions for accrued expense and accrued revenue. Think about what is to be accomplished by each of the adjustments required in this exercise. An accrued expense is an expense that has been incurred but not paid. The "incurred" part results in an increase in Expense (debit) and the "not paid" part results in an increase in Payable (credit). An accrued revenue is a revenue that has been earned but not received. The "earned" part results in an increase in Revenue (credit) and the "not received" part results in an increase in Receivable (debit). Notes: 1. In an adjusting entry to record accrued salaries expenses (expenses incurred, but not paid) the debit is to an expense account and the credit is to a liability account. The expense account is usually titled Salaries Expense. Possible names for the liability account include Salaries Payable and Accrued Salaries Payable. 2. In an adjusting entry to record accrued interest revenue (revenue earned but not received) the debit is to an asset account and the credit is to a revenue account. Possible names for that asset account are Interest Receivable and Accrued Interest Receivable. Possible names for the revenue account include Interest Revenue, Interest Income, and Interest Earned.

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SOLUTION PROBLEM #2

1. Adjusting Entry
Amount of Revenue or expense appearing on Income Statement Balance of asset or liability account at the end of the period Cash received or paid during the period Change in the asset or liability account from beg. to end of period. 2. Adjusting Entry: Original entry was: Supplies Expense 900 Cash 900 Since the Supplies account dropped from a beg. Balance of $400 to ending of $320, that means they need to expense $80 more for a total of $980. Amount of Revenue or expense appearing on Income Statement Balance of asset or liability account at the end of the period Cash received or paid during the period Change in the asset or liability account from beg. to end of period. 3. Adjusting Entry Amount of Revenue or expense appearing on Income Statement Balance of asset or liability account at the end of the period Cash received or paid during the period Change in the asset or liability account from beg. to end of period. 4. Adjusting Entry: The original entry was: Cash 54000 Subcrip. Revenue 54000 Since they only earned $52700 they need to adjust earned revenue downward by $1300. Amount of Revenue or expense appearing on Income Statement Balance of asset or liability account at the end of the period Cash received or paid during the period Change in the asset or liability account from beg. to end of period.

Supplies Expense Supplies $980 Expense $320 Supplies $900 ($80) Supplies Expense Supplies

$980 $980

$80 $80

$980 Expense $320 Supplies $900 ($80) Unearned Subscription Revenue $52700 Subscription Revenue $52700 $52700 Revenue $8000 liability $54000 $1300 Subscription Revenue $1300 Unearned Subscription Revenue $1300

$52700 Revenue $8000 liability $54000 $1300

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