Chapter 3, Problem 3.2BPR

(a)

To determine

Adjusting entries:

Adjusting entries refers to the entries that are made at the end of an accounting period in accordance with revenue recognition principle, and expenses recognition principle.  All adjusting entries affect at least one income statement account (revenue or expense), and one balance sheet account (asset or liability).

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

Ø Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and owners’ equities.

Ø Credit, all increase in liabilities, revenues, and owners’ equities, all decrease in assets, expenses.

Accrual basis of accounting:

Accrual basis of accounting refers to recognizing the financial transactions during the period in which the event occurs, even if the cash is not exchanged.

Income statement:

This is the financial statement of a company which shows all the revenues earned and expenses incurred by the company over a period of time.

Balance sheet:

This is the financial statement of a company which shows the grouping of similar assets and liabilities under subheadings.

To prepare: The adjusting entries in the books of Company IR at the end of the year.

Answer to Problem 3.2BPR

An adjusting entry for Supplies expenses:

In this case, Company IR recognized the supplies expenses at the end of the year. So, the necessary adjusting entry that the Company IR should record to recognize the supplies expense is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
November	30	Supplies expenses  (1)		2,620
		Supplies			2,620
		(To record the supplies expenses incurred at the end of the year)

Table (1)

Explanation of Solution

Working note:

Calculate the value of supplies expense

$\begin{array}{c}\text{Supplies}\text{expense}\text{=}\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{supplies}\\ \text{begining of the year}\end{array}\right)-\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{supplies}\text{on}\text{hand}\\ \text{at}\text{the}\text{end}\text{of}\text{the year}\end{array}\right)\\ =\left(\$3,170–\$550\right)\\ =\$2,620\end{array}$ (1)

Explanation:

• Supplies expense decreased the value of owner’s equity by $2,620; hence debit the supplies expenses for $2,620.
• Supplies are an asset, and it decreased the value of asset by $2,620, hence credit the supplies for $2,620.  

An adjusting entry for depreciation expenses:

In this case, Company IR recognized the depreciation expenses at the end of the year. So, the necessary adjusting entry that the Company IR should record to recognize the accrued expense is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
November	30	Depreciation expenses		1,675
		Accumulated depreciation-Equipment			1,675
		(To record the depreciation expenses incurred at the end of the year)

Table (2)

Explanation:

• Depreciation expense decreased the value of owner’s equity by $1,675; hence debit the depreciation expenses for $1,675.
• Accumulated depreciation is a contra-asset account, and it decreased the value of asset by $1,675, hence credit the accumulated depreciation for $1,675.  

An adjusting entry for rent expenses:

In this case, Company IR recognized the rent expenses at the end of the year. So, the necessary adjusting entry that the Company IR should record to recognize the prepaid expense is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
November	30	Rent expenses		8,500
		Prepaid rent			8,500
		(To record the rent expenses incurred at the end of the year)

Table (3)

Explanation:

• Rent expense decreased the value of owner’s equity by $8,500; hence debit the rent expenses for $8,500.
• Prepaid rent is an asset, and it decreased the value of asset by $6,000, hence credit the prepaid rent for $8,500.  

An adjusting entry for wages expenses:

In this case, Company IR recognized the wages expenses at the end of the year. So, the necessary adjusting entry that the Company IR should record to recognize the accrued expense is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
November	30	Wages expenses		2,000
		Wages payable			2,000
		(To record the wages expenses incurred at the end of the year)

Table (4)

Explanation:

• Wages expense decreased the value of owner’s equity by $2,000; hence debit the wages expenses for $2,000.
• Wages payable is a liability, and it increased the value of liability by $2,000, hence credit the wages payable for $2,000.  

An adjusting entry for unearned fees revenue:

In this case, Company IR received cash in advance before the service provided to customer. So, the necessary adjusting entry that the Company IR should record for the unearned fees revenue at the end of the year is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
November	30	Unearned fees revenue		6,000
		Fees earned (2)			6,000
		(To record the unearned fees revenue at the end of the year)

Table (5)

Working note:

Calculate the value of accrued wages at end of the October

$\begin{array}{c}\text{Fees earned}\text{=}\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{unearned fees}\\ \text{at the begining of the year}\end{array}\right)-\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{unearned fees}\\ \text{at}\text{the}\text{end}\text{of}\text{the year}\end{array}\right)\\ =\left(\$10,000–\$4,000\right)\\ =\$6,000\end{array}$ (2)

Explanation:

• Unearned fees revenue is a liability, and it decreased the value of liability by $6,000, hence debit the unearned fees revenue for $6,000.
• Fees earned increased owner’s equity by $6,000; hence credit the fees earned for $6,000.

An adjusting entry for accrued fees:

In this case, the Company IR recognized the fees at the end of the year. So, the necessary adjusting entry that the business should record for the accrued at end of the year is as follows:

Date		Description	Post. Ref	Debit ($)	Credit ($)
November	30	Accounts receivable		5,380
		Fees earned			5,380
		(To record the fees earned at end of the year)

Table (6)

Explanation:

• Account receivable is an asset, and it increased the value of asset by $5,380, hence debit the accounts receivable for $5,380. 
• Fees earned increased the value of owner’s equity by $5,380; hence credit the fees earned for $5,380.

(b)

To determine

The effects on the income statement, if adjusting entries are not recorded.

Answer to Problem 3.2BPR

The effects on the income statement, if the adjusting entries are not recorded are as follows:

Adjustment Not Recorded	Income Statement
	Revenue	Expenses	Net income
Depreciation expense		Understated by $1,675	Overstated by $1,675
Unearned fees	Understated by $6,000		Understated by $6,000

Table (7)

Explanation of Solution

Depreciation expense

Given entry would increase the depreciation expense account, and increase the accumulated depreciation account, if adjusting entry for depreciation expense is not recorded, and it will affect two accounts such as depreciation expense (expense), and accumulated depreciation (contra-asset). Hence the depreciation expense of $1,675 has been understated the value of total expense of the Company IR, and it overstated the value of net income by $1,675.

Unearned fees

Given entry would increase the fees earned account, and decrease the unearned fees account, if adjusting entry for unearned fees is not recorded, and it will affect two accounts such as fees earned (revenue), and unearned fees (liability). Hence the fees earned of $6,000 has been understated the value of total revenue of the Company IR, and it understated the value of net income by $6,000.

Conclusion

Hence, the revenues of the Company IR were understated by $6,000, and the expenses were understated by $1,675. Thus, the net income of Company AC was understated by $4,325 $\left(\$6,000-\$1,675\right)$.

(c)

To determine

The effects on the balance sheet, if adjusting entries are not recorded.

Answer to Problem 3.2BPR

The effects on the balance sheet, if the adjusting entries are not recorded are as follows:

Adjustment Not Recorded	Balance Sheet
	Assets	Liabilities	Owner’s Equity
Depreciation expense	Overstated by $1,675		Overstated by $1,675
Unearned fees		Overstated by $6,000	Understated by $6,000

Table (8)

Explanation of Solution

Depreciation expense

Given entry would increase the depreciation expense account, and increase the accumulated depreciation account, if adjusting entry for depreciation expense is not recorded, and it will affect two accounts such as depreciation expense (expense), and accumulated depreciation (contra-asset). Hence the depreciation expense of $1,675 has been overstated the value of assets of the Company IR, and understated depreciation expense overstates the owner’s equity by $1,675.

Unearned fees

Given entry would increase the fees earned account, and decrease the unearned fees account, if adjusting entry for unearned fees is not recorded, and it will affect two accounts such as fees earned (revenue), and unearned fees (liability). Hence the fees earned of $6,000 has been overstated the value of total liabilities of the Company IR, and understated fees earned understates the owners’ equity by $6,000.

Conclusion:

Hence, the assets of the Company IR were overstated by $1,675, and the liabilities were overstated by $6,000. Thus, the total liabilities ($6,000) and owner’s equity ($4,325) of Company IR was overstated by $1,675 $\left(\$6,000+\$4,325\right)$.

(d)

To determine

The effects on the “net increase or decrease in cash” on the statement of cash flow, if adjusting entries are not recorded.

Explanation of Solution

There is no effect on the “net increase or decrease in cash” on the statement of cash flow because, the adjusting entries are prepared under the accordance with the accrual basis of accounting. Hence, adjusting entries do not effect the cash flow statement of the company.