Chapter 4, Problem 6BP

a.

To determine

Prepare the adjusting entry as at December 31, Year 1.

Explanation of Solution

Adjusting entries: Adjusting entries are those entries which are recorded at the end of the year, to update the income statement accounts (revenue and expenses) and balance sheet accounts (assets, liabilities, and stockholders’ equity) to maintain the records according to accrual basis principle.

Prepare the adjusting entries:

Date	Account titles and Explanation	Debit ($)	Credit ($)
December 31	Unearned Member dues	25,200
	Client fees earned		25,200
	(To record  the unearned to earned revenue)
December 31	Insurance expense (1)	3,840
	Unexpired insurance		3,840
	(To record  the insurance expense)
December 31	Rent expense $\left(\frac{\$26,280}{3\text{ months}}\right)$	8,760
	Prepaid rent		8,760
	(To record the rent expense)
December 31	Office supplies expense (2)	2,064
	Office supplies		2,064
	(To record the office supplies expense)
December 31	Depreciation expense: Computer Equipment (3)	3,600
	Accumulated depreciation: Computer Equipment		3,600
	(To record the depreciation expense)
December 31	Interest expense (4)	900
	Interest payable		900
	(To record the interest expense)
December 31	Salaries expense	12,600
	Salaries payable		12,600
	(To record the salaries expense)
December 31	Income taxes expense	2,400
	Income taxes payable		2,400
	(To record the income tax expense)

Table (1)

1. To record the previously unearned revenue to earned revenue:

• Unearned revenue is a liability account and it is decreased. Therefore, debit unearned revenue with $25,200.
• Client revenue earned is a revenue account and it increases the stockholders’ equity account. Therefore, credit fees earned with $25,200.

3. To record the insurance expense:

• Insurance expense is an expense account and it decreases the stockholders’ equity account. Therefore, debit insurance expense with $3,840.
• Unexpired insurance is an asset account and it is decreased. Therefore, credit unexpired insurance with $3.840.

Working note:

Calculate the amount of insurance expense:

$\begin{array}{c}\text{Insurance expense}=\frac{\text{Policy amount}}{\text{Number of months }}\\ =\frac{\$23,040}{\text{6Months}}\\ =\$3,840\end{array}$ (1)

4. To record the rent expense:

• Rent expense is an expense account and it decreases the stockholders’ equity. Therefore, debit rent expense with $8,760.
• Prepaid rent is an asset account and it is decreased. Therefore, credit prepaid adverting with $8,760.

5. To record the office supplies expense:

• Office supplies expense is an expense account and it decreases the stockholders’ equity account. Therefore, debit office supplies expense with $2,064.
• Office supplies are an asset account and it is decreased. Therefore, credit office supplies with $2,064.

Working note:

Calculate the climbing supplies expense:

$\begin{array}{c}\text{Office supplies expenses}=\left(\begin{array}{l}\text{Office supplies in unadjusted trial balance}-\\ \text{Office supplies in hand}\end{array}\right)\\ =\$2,592-\$528\\ =\$2,064\end{array}$ (3)

6. To record the depreciation expense, Climbing Equipment:

• Depreciation expense is an expense account and it decreases the stockholders’ equity account. Therefore, debit depreciation expense with $3,600.
• Accumulated depreciation is a contra-account and it decreases the value of asset. Therefore, credit accumulated depreciation with $3,600.

Working note:

Calculate the amount of depreciation expense:

$\begin{array}{c}\text{Depreciation expense}=\frac{\text{Cost of the computer equipment}}{\text{Number of months depreciated}}\\ =\frac{\$129,600}{36\text{Months}}\\ =\$3,600\end{array}$ (3)

7. To record the interest expense:

• Interest expense is an expense account and it decreases the stockholders’ equity. Therefore, debit interest expenses with $900.
• Interest payable is a liability account and it is increased. Therefore, credit interest payable with $900.

Working note:

Calculate the amount of interest expense:

$\begin{array}{c}\text{Interest expense}=\text{Note payable amount}\times \text{Interest rate}\times \frac{\text{Number of months}}{\text{Months in a year}}\\ =\$108,000\times 10\%\times \frac{1\left(\text{December}\right)}{12}\\ =\$900\end{array}$ (4)

7. To record the salaries expense:

• Salaries expense is an expense account and it decreases the stockholders’ equity. Therefore, debit salaries expenses with $12,600.
• Salaries payable is a liability account and it is increased. Therefore, credit salaries payable with $12,600.

8. To record the income tax expense:

• Income tax expense is an expense account and it decreases the stockholders’ equity. Therefore, debit income tax expenses with $2,400.
• Income tax payable is a liability account and it is increased. Therefore, credit salaries payable with $2,400.

b.

To determine

Determine the amount for the given accounts that will be reported in the balance sheet for the Year 1.

Explanation of Solution

Determine the amount for the given accounts that will be reported in the balance sheet:

S.No	Particulars	Amount ($)
1	Cash (No adjustments)	$203,400
2	Unexpired insurance (unadjusted)	$15,360
	Less: Adjusting entry (2)	$3,840
	Unexpired insurance at December, Year 1	$11,520
3	Prepaid rent (unadjusted)	$17,520
	Less: Adjusting entry (3)	$8,760
	Prepaid rent at December, Year 1	$8,760
4	Office supplies (unadjusted)	$2,592
	Less: Adjusting entry (4)	$2,064
	Office supplies at December, Year 1	$528
5	Computer equipment (No adjustments)	$129,600
6	Accumulated depreciation: Computer equipment (unadjusted)	$64,800
	Add: Adjusting entry (5)	$3,600
	Accumulated depreciation at December, Year 1	$68,400
7	Accounts payable (No adjustments)	$5,160
8	Notes payable (No adjustments)	$108,000
9	Salaries payable (unadjusted)	0
	Add: Adjusting entry (7)	$12,600
	Salaries payable at December 31, Year 1	$12,600
10	Interest payable (unadjusted)	$8,100
	Add: Adjusting entry (6)	$900
	Interest payable at December 31, Year 1	$9,000
11	Income taxes payable (unadjusted)	$9,000
	Add: Adjusting entry (8)	$2,400
	Income taxes payable at December 31, Year 1	$11,400
12	Unearned client revenue (unadjusted)	$43,200
	Less: Adjusting entry (1)	$25,200
	Unearned client revenue at December 31, Year 1	$18,000

Table (2)

1. Amount of cash that is to be reported in the balance sheet is $203,400.

2. Amount of unexpired insurance that is to be reported in the balance sheet is $11,520.

3. Amount of prepaid rent that is to be reported in the balance sheet is $8,760.

4. Amount of office supplies that is to be reported in the balance sheet is $528.

5. Amount of computer equipment that is to be reported in the balance sheet is $129,600.

6. Amount of accumulated depreciation, computer equipment that is to be reported in the balance sheet is $68,400.

7. Amount of Accounts payable that is to be reported in the balance sheet is $5,160.

8. Amount of notes payable that is to be reported in the balance sheet is $108,000.

9. Amount of salaries payable that is to be reported in the balance sheet is $12,600.

10. Amount of interest payable that is to be reported in the balance sheet is $9,000.

11. Amount of income tax payable that is to be reported in the balance sheet is $11,400.

12. Amount of unearned member due that is to be reported in the balance sheet is $18,000.

c.

To determine

Explain the reason for not recording the advance payments from customers as revenue immediately.

Explanation of Solution

Following are the reason for not recording the advance payments from customers as revenue immediately:

According to the revenue recognition principle, the revenue is not recognized until it is earned. Company ME is following the revenue recognition principle. Various clients will be paying advance for the services that are to be provided in the future. When the services are provided, then the company converts the liability account (unearned member dues) to the revenue account (client fees earned).