Adjusting Entries(Quick Test #4 with Coaching)

The accrual method will result in a better matching of expenses with revenues (instead of recognizing or reporting an expense when it is paid).

The accrual method also results in the reporting of revenues in the accounting period in which they were earned (instead of reporting them when cash is received).

In addition, the accrual method results in a more complete balance sheet since it will report accounts receivable and prepaid expenses plus accounts payable, deferred revenues and other liabilities.

Under the accrual method of accounting, revenues are reported in the accounting period in which they are earned. Hence, the revenues that were earned in May should be reported on the May income statement.

In addition to the revenues being reported on the May income statement, the company's May 31 balance sheet will report the account receivable as an asset. The balance sheet will be in balance because revenues also cause an increase in retained earnings.

Under the accrual method of accounting, expenses (and the related liability) are reported in the accounting period in which they are incurred (when they occur). Since the $10,000 expense occurred on December 31, it must be reported on the December 31 income statement.

Since the $10,000 was not paid as of December 31, the liability must be reported on the December 31 balance sheet.

For these to be reported, the company must write an accrual adjusting entry to debit Repairs Expense and credit a liability account such as Accrued Expenses Payable or Accrued Liabilities.

The date used on the adjusting entries is usually the last day of the accounting period.

The expenses listed in the question will require accrual adjusting entries because it is common for these expenses to occur before the company receives a bill for the expenses or before it processes the paperwork.

For example, a retailer's use of electricity in June is likely to be measured on July 1 when the utility reads the electric meters. Next, the utility will calculate the cost of the electricity used and will mail the bill to the retailer. Hence, the electricity used in June will be paid by the retailer near the end of July or perhaps in early August.

In order for the electricity used in June to appear on the retailer's June income statement, and the liability to appear on the June 30 balance sheet, it is necessary to prepare an accrual adjusting entry as of June 30.

As of Tuesday, the company has a liability of $4,200 consisting of $3,000 (for the 5 days X $600 per day in the previous work week) plus $1,200 (for the Monday and Tuesday in the current work week X $600 per day).

The adjusting entry will debit expenses for $4,200 and will credit accrued liabilities for $4,200.

The items listed usually involve a payment that is made prior to the expenses occurring or prior to the revenues being earned. These situations require deferral adjusting entries (sometimes referred to as prepayment-type adjusting entries).

For example, a company is usually billed for 6 months of insurance coverage before the 6-month period begins. Therefore, there is no expense until the coverage period begins. If the company prepares monthly financial statements it will expense 1/6 of the amount each month.

Nearly every adjusting entry (accrual, deferral, other) will involve at least one balance sheet account and at least one income statement account.

Examples: Interest Payable & Interest Expense; Utilities Payable & Electricity Expense; Supplies & Supplies Expense; Prepaid Insurance & Insurance Expense; Deferred Revenues & Revenues.

The $3,000 cost for 6 months of insurance coverage means the company is incurring $500 of insurance expense in each of the months of December through May.

Given that the company began its operations on December 1, the balance needed in the account Insurance Expense at December 31 is $500. Since there is presently a $0 balance in Insurance Expense, the December 31 adjusting entry will require a debit of $500 to Insurance Expense.

The asset account Prepaid Insurance will need to have a debit balance of $2,500 on December 31, since 5 months at $500 are unexpired. Since the account Prepaid Insurance account presently has a debit balance of $3,000 the adjusting entry will have to credit Prepaid Insurance for $500.

The $3,000 cost for 6 months of insurance coverage means the company is incurring $500 of insurance expense in each of the months of December through May.

As of December 31, the asset account Prepaid Insurance needs to report a debit balance of $2,500 (5 months at $500 for the insurance that is unexpired). Since the account Prepaid Insurance presently has a $0 balance, the adjusting entry will need to debit Prepaid Insurance for $2,500.

Given that the company began its operations on December 1, the balance needed in the account Insurance Expense as of December 31 should be a debit balance of $500. Since there is presently a debit balance of $3,000 in Insurance Expense, the December 31 adjusting entry must include a credit to Insurance Expense for $2,500.

The asset account Promotion Supplies still has the debit balance of $25,000 from January 1. However, at December 31, this account needs to have a debit balance of $21,000 to reflect the actual amount of supplies on hand. Therefore, the December 31 adjusting entry will require a credit to Promotion Supplies for $4,000. The adjusting entry will also require a debit to Promotion Supplies Expense for $4,000.

As a result of the adjusting entry, the expense will be $214,000 (which is the $210,000 of promotion supplies that were purchased + $4,000 that was removed from the supplies inventory.)

The asset Promotion Supplies began the year with a debit balance of $25,000. Throughout the year this asset account was debited for the purchases of $210,000. Therefore, on December 31 (before the adjusting entry) the asset account Promotion Supplies has a debit balance of $235,000.

Since the cost of the actual supplies on hand at December 31 was given as $21,000, the asset account must have a debit balance of $21,000. Thus, the December 31 adjusting entry will need to credit Promotion Supplies for $214,000 and to debit Promotion Supplies Expense for $214,000.

The loan, having a principal balance of $200,000, is costing the company $1,500 per month ($200,000 X 9% X 1/12).

As of December 31, the company has incurred two months of interest (all of November and all of December). Therefore, the account Interest Expense needs to have a debit balance of $3,000. Since, the account has a $0 balance, the December 31 adjusting entry will need to debit Interest Expense for $3,000.

Since the company has not yet paid any of the interest, the balance sheet account Interest Payable must report a liability of $3,000 as of December 31. We assume that Interest Payable has a $0 balance and therefore the December 31 adjusting entry must credit Interest Payable for $3,000.

Under the accrual method of accounting, when a corporation incurs an expense but has not received a bill or paid the vendor as of the date of its balance sheet, the corporation should prepare an adjusting entry to accrue the expense and the liability.

The liabilities will increase when the adjusting entry credits a liability account such as Accrued Liabilities or Accrued Expenses Payable.

The expense will reduce the corporation's net income, which in turn will reduce retained earnings (a component of stockholders' equity).

The company is earning interest at the rate of $1,000 per month ($100,000 X 12% X 1/12) on the loan it made to a supplier.

Therefore as of December 31, the company should record an adjusting entry to accrue $1,000 of interest that it earned and has a right to receive.

The adjusting entry will be to debit Interest Receivable for $1,000 and to credit Interest Income for $1,000.

Since none of the work was done in December, none of the $20,000 has been earned. Therefore, there are no associated revenues to be reported in December.

Since the $20,000 transaction had been credited to Service Revenues, the adjusting entry must debit Service Revenues for $20,000 (which reduces Revenues) and credit a liability account such as Deferred Service Revenues or Unearned Service Revenues for $20,000.

As of December 31, the company has earned $6,000 of the $15,000 advance it had received. That means that the company has not yet earned $9,000.

Since the liability account Deferred Service Revenues has a credit balance of $15,000 before the adjusting entry, the adjusting entry must debit Deferred Service Revenues for $6,000 (which reduces the liability to a credit balance of $9,000) and credit Service Revenues for $6,000 (the amount that was earned).

A credit balance is acceptable for the contra asset account Allowance for Doubtful Accounts. The credit balance may be required in order to present a reduction to the balance in the asset Accounts Receivable.

A debit balance is not acceptable since a debit balance in the Allowance for Doubtful Accounts would be added to the balance in Accounts Receivable. This would result in an amount that is larger than the amount that the customers have been billed and still owe.

The allowance method for accounts receivable and bad debts expense means that a company anticipates that some of its accounts receivable will not be collected. An adjusting entry is written so that the estimated uncollectible amount will be reported in the contra asset account Allowance for Doubtful Accounts. (The other half of the adjusting entry is recorded in the income statement account Bad Debts Expense.) Note that the adjusting entry is recorded prior to knowing the specific accounts and amounts that will not be collected in full.

The alternative method known as the direct write-off method does not anticipate any uncollectible amounts. There is no bad debt expense until a specific account is identified as uncollectible and the account is written off (removed from Accounts Receivable). Hence, under the direct write-off method there is no Allowance account.

From the above comments, you can see that 1) the allowance method is most likely to report bad debts expense sooner, and 2) through the Allowance for Doubtful Accounts the net realizable value of the receivables will be reduced sooner.

The allowance method for bad debts expense is preferred for financial reporting since the bad debts expense is likely to be recognized closer to the time of the sales, and the amount of accounts receivable is reported at a more realistic, lower amount.

The Allowance for Doubtful Accounts should report a credit balance equal to the amount of accounts receivable that are not likely to be collected.

In this question, it is estimated that $3,000 of the accounts receivable will not be collected. Therefore the account Allowance for Doubtful Accounts will need to have a credit balance of $3,000. Since the account presently has a credit balance of $900, an additional credit of $2,100 must be entered into the Allowance for Doubtful Accounts and the account Bad Debts Expense must be debited for $2,100.

The Allowance for Doubtful Accounts should report a credit balance equal to the amount of accounts receivable that are not likely to be collected.

In this question, it is estimated that $3,000 of the accounts receivable will not be collected. Therefore the account Allowance for Doubtful Accounts will need to have a credit balance of $3,000. Since the account presently has a debit balance of $600, there needs to be a credit of $3,600 entered into the Allowance for Doubtful Accounts and the account Bad Debts Expense must be debited for $3,600.

Under the allowance method for recording bad debts expense, when a specific account receivable is identified as uncollectible, the entry will include a debit to Allowance for Doubtful Accounts and a credit to Accounts Receivable for the amount that will not be collected.

The main purpose of depreciation is to spread or allocate the cost of buildings and equipment to expense in a systematic and rational manner. For the financial statements it is common to allocate the cost over the asset's years of useful life by using the straight-line method.

The routine depreciation entry for equipment will include a credit to a contra asset account. In this case the credit is recorded in Accumulated Depreciation of Equipment.

Since the equipment was acquired and put into service in the middle of the year, there will be only one-half of a year's depreciation. Therefore, the answer is $10,000 as calculated here:

Depreciation for a full year is: 1) cost minus estimated salvage value, 2) divided by estimated years of useful life. For this question it means 1) $154,000 minus $14,000, 2) divided by 7 years. Hence the depreciation for a full year is $20,000. For a half-year the depreciation will be $10,000.

If the emergency repair is not recognized through an adjusting entry, Repairs Expense wil be too small and Accrued Liabilities will be too small.

Since expenses cause owner's equity to decrease, failure to accrue the repair expense will mean that owner's equity will be too large.

If the customer's $15,000 deposit is not deferred to the next accounting period, the current period's reported revenues will be too large. Since revenues are too large, the company's owner's equity will also be too large.

Without the deferral adjusting entry the liabilities (Deferred Revenues or Customer Deposits) listed on the current balance sheet will be too small.

The accounts are contra asset accounts. The reason is that the accounts are presented on the balance sheet in the asset section, but their balances will be credit balances or zero balances. (The normal balances of asset accounts are debit balances.)

Accrual adjusting entries are prepared because the documents have not been processed for expenses that have occurred or for revenues that have been earned. However, it is likely that the documents will be processed in the following accounting period. Therefore, there is a risk that an expense or revenue will be recorded again when the documents are processed. To avoid the risk of this double-counting, reversing entries are prepared on the first day of the next accounting period to remove the previous period's accrual adjusting entries.

For instance, a retailer's cost of the electricity that it used in June should be reported on the June income statement. Since the electric bill won't be received until July, an accrual adjusting entry dated June 30 is recorded to debit an expense and credit a liability. However, this could lead to a potential problem when the June electric bill arrives in July. To avoid charging the June electricity expense twice (once with the accrual adjusting entry and again when the electric bill is received), a reversing entry is recorded on July 1 to remove the June 30 accrual.The reversing entry on July 1 will debit the liability and will credit the expense. The credit to expense will disappear when the actual bill for June's electricity gets debited to expense in July.