Chapter 4, Problem 4.6AP

(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.  The purpose of adjusting entries is to adjust the revenue, and the expenses during the period in which they actually occurs.

Rules of Debit and Credit:

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

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease

Generally Accepted Accounting Principle (GAAP):

Two generally accepted accounting principles that relates to adjusting the accounts are as follows:

• The revenue recognition principle
• The expenses recognition principle

The revenue recognition principle:

The revenue recognition principle refers to the revenue that should be recognized in the time period, when the performance obligation (sales or services) of the company is completed.

The expense recognition principle:

The expense recognition principle refers to the expenses that should match with revenue (matching principle) in the period when the company incurred expenses in order to generate the revenue.

To prepare:  The adjusting journal entries in the book of RT Court at June 31, 2017.

Explanation of Solution

The adjusting journal entries in the book of RT Court at the end of the quarter are as follows:

1. An adjusting entry for unearned rent revenue:

In this case, RT Court has earned unearned rent revenue of $57,000, and it is wrongly included in the rent revenue. Hence, RT Court should record $57,000 as unearned rent revenue to be adjusted from rent revenue is as follows:

Date	Account Title and Description	Debit ($)	Credit ($)
June 30, 2017	Rent revenue	57,000
	Unearned rent revenue		57,000
	(To record the unearned rent revenue wrongly included with rent revenue)

Table (1)

Description:

• Rent revenue is a component of the value of stockholders’ equity, and it decreases the value of rent revenue by $57,000; hence debit the rent revenue for $57,000.
• Unearned rent revenue is a liability, and it increases the value of liability by $57,000, hence credit the unearned rent revenue for $57,000.

2. An adjusting entry for Supplies expenses:

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

Date	Account Titles and Description	Debit ($)	Credit ($)
June 30, 2017	Supplies expenses (1)	6,400
	Supplies		6,400
	(To record the supplies expenses incurred at the end of the quarter)

Table (2)

Working note:

Calculate the value of supplies expense at end of the quarter

$\begin{array}{c}\text{Supplies}\text{expense}\text{=}\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{supplies}\\ \text{begining of the quarter}\end{array}\right)-\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{supplies}\text{on}\text{hand}\\ \text{at}\text{the}\text{end}\text{of}\text{the quarter}\end{array}\right)\\ =\left(\$8,200–\$1,800\right)\\ =\$6,400\end{array}$ (1)

Description:

• Supplies expense decreases the value of stockholders’ equity by $6,400; hence debit the supplies expenses for $6,400.
• Supplies are an asset, and it decreases the value of asset by $6,400, hence credit the supplies for $6,400.  

3. An adjusting entry for insurance expense:

In this case, RT Court recognized the insurance expenses at the end of the quarter. So, the necessary adjusting entry that the RT Court should record to recognize the insurance expense is as follows:

Date	Account Titles and Description	Debit ($)	Credit ($)
June 30, 2017	Insurance expense (2)	3,600
	Prepaid insurance		3,600
	(To record the insurance expenses incurred at the end of the quarter)

Table (3)

Calculate the value of insurance expense at end of the quarter

$\begin{array}{c}\text{Insurance}\text{expense}\text{=}\left[\text{Prepaid insurance}\times \frac{\text{No}\text{. of months in a quarter}}{\text{No}\text{. of months in a year}}\right]\\ =\$14,400\times \frac{3\text{ months}}{\text{12 months}}\\ =\$3,600\end{array}$ (2)

Description:

• Insurance expense decreases the value of stockholders’ equity by $3,600; hence debit the insurance expense for $3,600.
• Prepaid insurance is an asset, and it decreases the value of asset by $3,600, hence credit the prepaid insurance for $3,600. 

4.  An adjusting entry for accrued expenses:

In this case, RT Court incurred the advertising expense, repairs and maintenance expense, and utilities expense but cash is not yet paid.  So, the necessary adjusting entry that the RT Court should record to recognize the all accrued expense is as follows:

Date	Account Title and Description	Debit ($)	Credit ($)
June 30, 2017	Advertising expense	110
	Maintenance and repairs expense	4,450
	Utilities expense	215
	Accounts payable		4,775
	(To record all  expenses incurred at the end of the quarter)

Table (4)

Description:

• Advertising expense, maintenance and repairs expense, and utilities expense decreases the value of stockholders’ equity by $4775; hence debit all expense accounts for $4,775.
• Accounts payable is a liability, and it increases the value of liability by $4,775, hence credit the accounts payable for $4,775.

5.  An adjusting entry for salaries and wages payable:

In this case, RT Court incurred the salaries and wages expense but cash is not yet paid.  So, the necessary adjusting entry that the RT Court should record to recognize the accrued expense is as follows:

Date	Account Title and Description	Debit ($)	Credit ($)
June 30, 2017	Salaries and wages expense (3)	1,200
	Salaries and wages payable		1,200
	(To record the salaries and wages expense incurred at the end of the quarter)

Table (5)

Calculate the value of salaries and wages expense at end of the quarter

$\begin{array}{c}\text{Salaries and wages expense}\text{=}\left[\begin{array}{l}\text{Wages expense per day}\times \\ \text{No}\text{. of days wages incurred during the quarter}\end{array}\right]\\ =\$300\times 4\\ =\$1,200\end{array}$ (3)

Description:

• Salaries and wages expense decreases the value of stockholders’ equity by $1,200 hence, debit the salaries and wages expense for $1,200.
• Salaries and wages payable is a liability, and it increases the value of liability by $1,200, hence credit the salaries and wages payable for $1,200.

6. An adjusting entry for interest payable:

In this case, RT Court incurred the interest expenses but cash is not yet paid.  So, the necessary adjusting entry that the RT Court should record to recognize the accrued expense is as follows:

Date	Account Title and Description	Debit ($)	Credit ($)
June 30, 2017	Interest expense (4)	140
	Interest payable		140
	(To record the interest expense incurred at the end of the quarter)

Table (6)

Working note:

Calculate the value of interest expense at the end of the May month

$\begin{array}{c}\text{Interest expense}\text{=}\left[\begin{array}{l}\left(\text{Note payable}\times \text{Annual interest rate}\right)\times \\ \frac{\begin{array}{l}\text{No}\text{. of months interest occured in a quarter }\\ \text{(July,1 to August, 31) }\end{array}}{\text{No}\text{. of months in a year}}\end{array}\right]\\ \text{=}\left(\$14,000\times \frac{6}{100}\right)\times \frac{2\text{ months}}{12\text{ months}}\\ \text{=\$140}\end{array}$ (4)

Description:

• Interest expense decreases the value of stockholders’ equity by $140; hence debit the interest expense for $140.
• Interest payable is a liability, and it increases the value of liability by $140, hence credit the interest payable for $140.

7. An adjusting entry for income tax expenses:

In this case, RT Court recognized the income tax expenses at the end of the quarter. So, the necessary adjusting entry that the RT Court should record to recognize the accrued expense is as follows:

Date	Account Titles and Description	Debit ($)	Credit ($)
June 30, 2017	Income tax expense	13,400
	Income tax payable		13,400
	(To record the income tax expenses incurred at the end of the quarter)

Table (7)

Description:

• Income tax expense decreases the value of stockholders’ equity by $13,400; hence debit the income tax expenses for $13,400.
• Income tax payable is a liability, and it increases the value of liability by $13,400, hence credit the income tax payable for $13,400.

(b)

To determine

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

To prepare: The correct income statement of RT Court.

Explanation of Solution

The income statement of RT Court for the quarter ended June 30, 2017 is as follows:

RT Court
Income Statement
For the quarter ended June 30, 2017
Particulars	$	$
Revenue
Rent revenue (5)	155,000
Total revenue (A)		155,000
Less:  Expenses
Salaries and wages expenses (6)	81,700
Income tax expense	13,400
Maintenance and repairs expense (7)	8,750
Supplies expense	6,400
Advertising expense (8)	3,910
Insurance expense	3,600
Depreciation expense	2,700
Utilities expense (9)	1,115
Interest expense	140
Total Expenses (B)		121,715
Net income $\left(\text{A–B}\right)$		33,285

Table (8)

Hence, the correct net income of RT Court is $33,285.

Working note:

Calculate the correct value of the rent revenue after adjustment

$\begin{array}{c}\text{Rent revenue = Incorrect rent revenue – Unearned rent revenue}\\ \text{=\$212,000 – \$57,000}\\ \text{=\$155,000}\end{array}$ (5)

Hence, the correct value of the rent revenue is $155,000.

Calculate the correct value of salaries and wages expense

$\begin{array}{c}\text{Salaries and wages expense = }\left[\begin{array}{l}\text{Salaries and wages expense }\\ \text{(before adjustement) + }\\ \text{Accrued expense for the quarter}\end{array}\right]\\ \text{=\$80,500 + \$1,200}\\ \text{=\$81,700}\end{array}$ (6)

Hence, the correct value of the salaries and wages expense is $81,700.

Calculate the correct value of maintenance and repairs expense

$\begin{array}{c}\text{Maintenance and repairs expense = }\left[\begin{array}{l}\text{Maintenance and repairs expense }\\ \text{(before adjustement) + }\\ \text{Accrued expense for the quarter}\end{array}\right]\\ \text{=\$4,300 + \$4,450}\\ \text{=\$8,750}\end{array}$ (7)

Hence, the correct value of the maintenance and repairs expense is $8,750.

Calculate the correct value of advertising expense

$\begin{array}{c}\text{Advertising expense = }\left[\begin{array}{l}\text{Advertising expense }\\ \text{(before adjustement) + }\\ \text{Accrued advertising expense for the quarter}\end{array}\right]\\ \text{=\$3,800 + \$110}\\ \text{=\$3,910}\end{array}$ (8)

Hence, the correct value of the advertising expense is $3,910.

Calculate the correct value of utilities expense

$\begin{array}{c}\text{Utilities expense = }\left[\begin{array}{l}\text{Utilities expense }\\ \text{(before adjustement) + }\\ \text{Accrued utilities expense for the quarter}\end{array}\right]\\ \text{=\$900 + \$215}\\ \text{=\$1,115}\end{array}$ (9)

Hence, the correct value of the utilities expense is $1,115.

Conclusion

Therefore, the correct net income of RT Court for the quarter end June 30, 2017 is $33,285.

(c)

To determine

To explain: The effects of GAAP principle which was not recognized at the time of preparing the income statement.

Explanation of Solution

The effect of Generally Accepted Accounting Principle (GAAP) which was not recognized at the time of preparing the income statement is as follows:

• As per revenue recognition principle, the revenue that should be recognized during the time period, when the performance obligation (sales or services) of the company is completed. Rental revenues of RT Court include the advance rental payments received for summer occupancy. In this case, RT Court recorded that the rent revenue of $57,000 was recorded before the performance of obligation is completed; hence the rental revenue of $57,000 should not be reported as revenue of RT Court for the quarter ended 30, 2017.
• As per expense recognition principle, the expenses should match with revenue in the period when the company incurred the expenses in order to generate the revenue.  RT Court should record all the expenses during the period April 1 to June 30, 2017.
• The difference in reported revenue is $57,000 $\left(\$212,000–\$155,000\right)$, and the difference in the reported expense is $29,515 $\left(\$121,715-\$92,200\right)$, because RT Court overstated the rent revenue of $57,000, and the understated the expenses of $29,515 (all accrued expenses recognized at the end of the quarter).

Conclusion

Therefore, the overstatement of revenues plus the understatement of expenses $\left(\$57,000+\$29,515\right)$ equals the difference in the reported income of $86,515 $\left(\$119,800–\$33,285\right)$.