ACG Ch 4

On June 1 the Darius Co. purchased a photocopy machine for $9,000. The estimated annual depreciation on the machine is $1,800. If the company prepares annual financial statements on December 31, the appropriate adjusting journal entry to make on December 31 of the first year would be a

$1,050 debit to Depreciation Expense and a $1,050 credit to Accumulated Depreciation. Solution: The correct adjusting records depreciation expense and accumulated depreciation for the 7 months between June 1 and December 31 (i.e., $1,800 per year x 7/12 = $1,050). Chapter 4, Learning objective 4

On December 31, but before any year-end adjustments, McCarthy Company's Prepaid Insurance account had a balance of $2,700. It was determined that $1,500 of the Prepaid Insurance had expired. The Insurance Expense for the year would be

$1,500. Solution: When a company pays in advance for prepaid insurance, the company increases prepaid insurance and decreases cash. This transaction is an asset exchange. At the end of the accounting period, the company record an adjusting entry to reduce prepaid insurance by the portion used, consumed, or expired during the year and to write-of or expense that portion as insurance expense. The adjusting entry would reduce prepaid insurance and recognize insurance expense of $1,500. Q,4,4,5

Determine the amount that will be reported as retained earnings on the post-closing trial balance.

$10,000 Solution: Permanent accounts (i.e., assets, liabilities, and equities) are not closed. Temporary accounts (i.e., revenues, expenses, and dividends) are closed to retained earnings (i.e., an Income Summary account can be used as an intermediate step). Closing revenues increases retained earnings. Closing dividends and expenses decreases retained earnings. Post-closing: Ending retained earnings = beginning retained earnings + revenues - expenses - dividends = $6,000 + 8,000 - 1,000 - 1,000 - 2,000 = $10,000 Q,4,6,2

The following is information is from Clark Corporation's financial records for the current fiscal year. i. Cash received from customers, $230,000 ii. Revenue earned, $255,000 iii. Cash paid for wages, $110,000 iv. Wage expense incurred, $115,000 v. Cash paid during the current year for computers that will be used for 3 years, $30,000 vi. Depreciation expense, $10,000 vii. Proceeds from issuing debt, $30,000 viii. Interest incurred on debt, $3,000 ix. Cash paid for supplies, $4,000 x. Supplies expense incurred, $2,000 What is the company's net income for the current year using the accrual basis of accounting?

$125,000 Solution: Net income using the accrual basis = Revenue earned - expenses incurred including prepaids Net income using the accrual basis = $255,000 - 115,000 - 10,000 - 3,000 - 2,000 = $125,000 Chapter 4, Learning objective 2, Pool 3

Bonita Realty Management Co. received a check for $32,400 on August 1, which represents a one year advance payment of rent on an office it rents to a client. Unearned Rent Revenue was credited for the full $32,400. Financial statements are prepared on December 31. The appropriate adjusting journal entry to make on December 31 of the first year would be a

$13,500 debit to Unearned Rent Revenue and a $13,500 credit to Rent Revenue. Solution: The year-end adjusting entry reduces the liability (i.e., Unearned Revenue) and increases Revenue for the amount of revenue earned during this accounting period. Revenue earned Aug. through Dec. = 32,400 x 5/12 = 13,500 Chapter 4, Learning objective 4

On June 1, Long Corporation signed a $36,000, 16%, 2-year note to help finance renovations being made to the corporation headquarters. Assuming interest is accrued only when the year ends on December 31, the appropriate journal entry for the first year would be a

$3,360 debit to Interest Expense and a $3,360 credit to Interest Payable. Solution: This entry correctly adjusts the accounts and interest incurred for a seven month period. ($36,000 x 0.16 x 7/12 = $3,360) Chapter 4, Learning objective 5

On May 1, Mesa Verde, Inc. purchased a 2-year insurance policy for $15,600. Prepaid Insurance was debited for the entire amount. On December 31, when the annual financial statements are prepared, the appropriate adjusting journal entry would be a

$5,200 debit to Insurance Expense and a $5,200 credit to Prepaid Insurance. Solution: Learning objective 4 This entry correctly adjusts the accounts to recognize that six months of the 36 month policy have expired and are recorded as expense. Monthly rate = $15,600/24 = $650 per month. Expense the amount for May. 1 through Dec. 31: $650 x 8 = $5,200

Employees at the Waco Waffle House were paid on Friday, December 28 for the five days ending on December 28. The next payday is Friday, January 4. Employees work 5 days a week. The weekly payroll amounts to $3,150. The appropriate adjusting journal entry on December 31 would be to credit Salaries and Wages Payable for

$630. Solution: Employees work on December 31, but they will not be paid until January 4. At the end of December 31, the company owes employees for one days of the five day work week (i.e., $3,150 x 1/5 = $630). Chapter 4, Learning objective 5

After closing entries have been journalized and posted, the post-closing trial balance total for the credit column will be

$7,200. Solution: The difference between (i) the adjusted trial balance and (ii) the post-closing trial balance is the effect of the closing entries. Closing entries transfer end-of-period balances from the revenue accounts, expense accounts, and dividend account to the retained earnings account. The closing process reduces revenue accounts to zero and increases retained earnings, and this merely reduces the credit balance in revenue accounts and increases the credit balance in retained earnings (i.e., the total debits balance and total credit balance do not change when revenue is closed). In contrast, the closing process reduces expense and dividend accounts to zero (i.e., which reduces the total debits) and decreases retained earnings lowing the credit balance in retained earnings. So, closing expenses and dividends lowers both the total debit balance and the total credit balance. Total credits in the post-closing trial balance = the total credits of the adjusted trial balance - expenses and dividends (if any). Total credits in the post-closing trial balance = 8,450 - 150 - 600 - 500 = 7,200 Chapter 4, Learning objective 7

Bonita Realty Management Co. received a check for $30,000 on October 1, which represents a one year advance payment of rent on an office it rents to a client. Unearned Rent Revenue was credited for the full $30,000. Financial statements are prepared on December 31. The appropriate adjusting journal entry to make on December 31 of the first year would be a

$7,500 debit to Unearned Rent Revenue and a $7,500 credit to Rent Revenue. Solution: The year-end adjusting entry reduces the liability (i.e., Unearned Revenue) and increases Revenue for the amount of revenue earned during this accounting period. Revenue earned Oct. through Dec. = 30,000 x 3/12 = 7,500. Chapter 4, Learning objective 4

On August 1 the Darius Co. purchased a photocopy machine for $12,000. The estimated annual depreciation on the machine is $2,040. If the company prepares annual financial statements on December 31, the appropriate adjusting journal entry to make on December 31 of the first year would be a

$850 debit to Depreciation Expense and a $850 credit to Accumulated Depreciation. Solution: The correct adjusting records depreciation expense and accumulated depreciation for the 5 months between August 1 and December 31 (i.e., $2,040 per year x 5/12 = $850). Chapter 4, Learning objective 4

The following is information is from Clark Corporation's financial records for the current fiscal year. i. Cash received from customers, $230,000 ii. Revenue earned, $255,000 iii. Cash paid for wages, $110,000 iv. Wage expense incurred, $115,000 v. Cash paid during the current year for computers that will be used for 3 years, $30,000 vi. Depreciation expense, $10,000 vii. Proceeds from issuing debt (e.g., borrowed money from a bank), $30,000 viii. Interest incurred on debt, $3,000 ix. Cash paid for supplies, $4,000 x. Supplies expense incurred, $2,000 What is the company's net income for the current year using the cash-basis of accounting?

$86,000 Solution: Net income using the cash-basis = Cash collected from customers - cash paid for expenses incurred including prepaid expenses Net income using the cash-basis = $230,000 - 110,000 - 30,000 - 4,000 = $86,000 Chapter 4, Learning objective 2, Pool 4

FastAct Company pays its employee his wage each Friday. The most recent payment occurred on Friday, December 27. The next payroll will be paid on January 3. There are two more working days in December after December 27. The employee works 5 days a week and the company pays $2,500 per week in wages. What will be the adjusting entry to accrue wages expense at the end of December?

A debit to Salaries and Wages Expense for $1,000 Solution: Learning objective 5 Two days' wages need to be recorded for the current year even though the employer will not pay its employees for those days until Jan. 3 of next year. Two days' wage = $2,500 x 2/5 = $1,000. Expenses increase with debits.

FastAct Company pays its employees their wages each Friday. The most recent payment occurred on Friday, December 28. The next payroll will be paid on January 4. There is one more work day in December after December 28th. Employees work 5 days a week and the company pays $2,000 per day in wages. What will the adjusting entry to accrue wages expense at the end of December include?

A debit to Salaries and Wages Expense for $2,000 Solution: Learning objective 5 One day's wage needs to be recorded for the current year even though the employer will not pay its employees for that day until Jan. 4 of next year. One day's wage = $2,000 per day x 1 day = $2,000. Expenses are increased with debits.

Which one of the following is not a proper justification for adjusting entries?

Adjusting entries are necessary to bring the general ledger accounts in line with the budget. Solution: Adjusting entries are journalized and posted in order for revenues to be recorded in the period in which the performance obligations are satisfied and for expenses to be recognized in the period in which they are incurred. So, adjusting entries ensure that the revenue recognition and expense recognition principles are followed. Note that if firms reported only their lifetime operations when they cease to exist (rather than reporting results for fiscal periods (e.g., months, quarters, years) adjusting entries would not be required. Adjusting entries are not made to comply with budgets. Chapter 4, Learning objective 3, Pool 1

If revenues are recognized only when a customer pays, what method of accounting is being used?

Cash-basis Solution: Learning objective 2 Under the cash-basis of accounting, revenues are recognized when cash is received rather than when the performance obligation is satisfied. It is the accrual-basis of accounting that recognizes revenue when a performance obligation is satisfied. If an organization recognizes the revenue when the customer pays, the organization is using the cash-basis of accounting.

Which principle dictates that efforts (i.e., expenses) be matched with results (i.e., revenues)?

Expense recognition principle Solution: Learning objective 1 The expense recognition principle requires that expenses be matched to revenues; expenses are recognized in the period when they helped generate revenues. The historical cost principle states that when assets are purchased, they should be recorded at cost, not that efforts be matched with results. The periodicity assumption states that the life of a business can be divided into artificial time periods, not that efforts be matched with results. The revenue recognition principle states that revenue should be recorded in the period in which the performance obligation is satisfied, not that efforts be matched with results.

The accounting cycle is a series of certain steps that businesses, such as corporations, perform in sequence and repeat in each accounting period. Although steps may be missing among the options listed below, which of the following lists steps of the accounting cycle in their correct order?

Journalize the transactions, journalize the adjusting entries, and prepare a post-closing trial balanc Solution: The correct order is (i) use source documents to analyze transactions, (ii) journalize transactions, (iii) post transactions to the ledger, (iv) prepare the trial balance, (v) journalize and post the adjusting entries, (vi) prepare the adjusted trial balance, (vii) prepare the financial statements, (viii) journalize and post the closing entries, (ix) and prepare the post-closing trial balance. Chapter 4, Learning objective 8

Which of the following is correct concerning the adjusted trial balance?

Solution: An adjusted trial balance proves the equality of the total debit balances and the total credit balances in the ledger after all adjustments are made. The adjusted trial balance provides the primary basis for the preparation of financial statements. The company prepares the adjusted trial balance after it has journalized and posted the adjusting entries. Chapter 4, Learning objective 6

Adjusting entries are recorded to ensure that

Solution: Adjusting entries are journalized and posted in order for revenues to be recorded in the period in which the performance obligations are satisfied and for expenses to be recognized in the period in which they are incurred. So, adjusting entries ensure that the revenue recognition and expense recognition principles are followed. Note that if firms reported only their lifetime operations when they cease to exist (rather than reporting results for fiscal periods (e.g., months, quarters, years) adjusting entries would not be required. Adjusting entries are not recorded to comply with budgets. Q,4,3,1

The difference between an asset's cost and its accumulated depreciation is called

book value. Solution: Learning objective 4 Book value is cost less accumulated depreciation. Market value is the value at which the item could be sold under normal selling conditions. Fair value is the value at which the item could be sold under normal selling conditions. "Real value" does not have a specific meaning in the context of accounting.

The following information is from the Income Statement of the Dirt Poor Laundry Service: The closing entries includes a:

debit to Income Summary for $3,050. Solution: Closing entries close revenue accounts and expense accounts to an account called "income summary" and then closes the income summary account to the retained earnings account. Also, the dividends account is also closed, but it is closed directly to retained earnings. First, close the revenue accounts: Debit: Service Revenue for $5,500 Credit: Income Summary for $5,500 Second, close the expense accounts: Debit: Income Summary for $3,050 Credit: Salaries and Wages Expense for $1,950 Credit: Advertising Expense for $500 Credit: Rent Expense for $300 Credit: Supplies Expense for $200 Credit: Insurance Expense for $100 Third, close the Income Summary account: Debit: Income Summary for $2,450 Credit: Retained Earnings for $2,450 There is no dividends account balance to be closed. Chapter 4, Learning objective 7

Intuitive Design Company started business this year and it purchased $7,000 of office supplies and debited Supplies for the full cost. Supplies on hand at the end of the accounting period were $800. The company's appropriate adjusting journal entry to be made would be a

debit to Supplies Expense for $6,200 and a credit to Supplies for $6,200. Solution: Learning objective 4 Supplies expense can be computed as beginning supplies plus the cost of supplies purchased in the current period minus the cost of supplies on hand at the end of the period. Since this company started business this year (and no beginning supplies were mentioned), beginning supplies should be determined to be zero. Thus, supplies expense = $0 + $7,000 - $800 = $6,200. The year-end adjusting journal entry to record Supplies Expense (and to decrease Supplies to the correct ending balance) would be a debit to Supplies Expense for $6,200 and a credit to Supplies for $6,200.

Year-end adjusting entries for prepaid expenses

decrease assets and increase expenses. Solution: When a company pays before receiving goods or services, it records the decrease in cash and an increase in a different asset (e.g., supplies, prepaid insurance, prepaid rent). At the end of the accounting period, the company adjusts its prepaid expense accounts to reflect that the company has fully or partially consumed them through use or the passage of time (e.g., decrease prepaid insurance for the months of coverage used before the end of the accounting period). Also, the company adjusts its expenses upward by that same amount (e.g., increase insurance expense) to show it was incurred before the end of the period. Q,4,4,1

During the adjusting process two transactions were neglected or omitted. The first is for unearned rent revenue of which $450 was earned during the period, the second was for accrued interest payable of which $275 is owed for the period. As a result of these omissions

net income is understated by $175. Solution: The omission associated with unearned rent revenues increases net income by $450 while the omission of accrued expenses, interest expense and interest payable, increases expenses and liabilities by $275. As a result, revenues are understated by $450 while expenses are understated by $275 so net income is understated by $175. Assets are not affected by these errors but liabilities are overstated by $175. Chapter 4, Learning objective 5

In Year 1, Costello Company performed work for a customer and billed the customer $10,000; it also paid wage expenses of $3,000. In Year 2, the customer pays Costello for the services it received in Year 1. If Costello uses the accrual-basis of accounting, then Costello will report

revenue of $10,000 and expense of $3,000 in Year 1. Solution: Learning objective 2 The accrual-basis of accounting records revenues when the performance obligation is satisfied and expenses when incurred. The services were performed in Year 1 so the company should recognize the revenue in Year 1 even though the customer did not pay the company until Year 2. The expenses were incurred in Year 1 so the company should recognized the expense in Year 1 regardless of when the company paid the expenses.

In Year 1, Costello Company performed work for a customer and billed the customer $12,000. In Year 1, Costello Company also incurred and paid wage expenses of $4,000. In Year 2, the customer pays for the services it received from Costello Company in Year 1. If Costello uses the accrual-basis of accounting, then Costello will report

revenue of $12,000 and expense of $4,000 in Year 1 Solution: Learning objective 2 The accrual-basis of accounting records revenues when the performance obligation is satisfied and expenses when incurred. The services were performed in Year 1 so the company should recognize the revenue in Year 1 even though the customer did not pay the company until Year 2. The expenses were incurred in Year 1 so the company should recognized the expense in Year 1 regardless of when the company paid the expenses.

A company has unearned revenues on its books. If the company fails to record a year-end adjusting entry for unearned revenues, then its financial statements

understate retained earnings and understate revenues. Solution: The appropriate adjusting entry would reduce unearned revenues (i.e., a liability) through a debit entry and it would increase revenues through a credit entry. Not making this adjusting entry (or omitting it it) would cause unearned revenues (and liabilities) to be overstated and it would cause revenues (and retained earnings, net income, and stockholders' equity) to be understated. Chapter 4, Learning objective 4

A company has unearned revenues on its books. If the company fails to record a year-end adjusting entry for unearned revenues, then its financial statements

understate revenues and overstate liabilities. Solution: The appropriate adjusting entry would reduce unearned revenues (i.e., a liability) through a debit entry and it would increase revenues through a credit entry. Not making this adjusting entry (or omitting it it) would cause unearned revenues (and liabilities) to be overstated and it would cause revenues (and retained earnings, net income, and stockholders' equity) to be understated. Chapter 4, Learning objective 4