Chapter 6, Problem 1CTP

The Trial Balance section of the worksheet for Contemporary Fashions for the period ended December 31, 2019, appears below. Adjustments data are also given.

ADJUSTMENTS

1. a. Supplies used, $3,600
2. b. Expired insurance, $2,400
3. c. Depreciation expense for machinery, $1,200

INSTRUCTIONS

1. 1. Complete the worksheet.
2. 2. Prepare an income statement.
3. 3. Prepare a statement of owner’s equity.
4. 4. Prepare a balance sheet.
5. 5. Journalize the adjusting entries in the general journal, page 3.
6. 6. Journalize the closing entries in the general journal, page 4.
7. 7. Prepare a postclosing trial balance.

Analyze: If the adjusting entry for expired insurance had been recorded in error as a credit to Insurance Expense and a debit to Prepaid Insurance for $2,400, what reported net income would have resulted?

To determine

Complete the worksheet for C Fashions for the month ended December 31, 2019.

Explanation of Solution

Worksheet: Worksheet is an accounting tool that helps accountants to record adjustments and up-date balances required to prepare financial statements. Worksheet is a central place where trial balance, adjustments, adjusted trial balance, income statement, and balance sheet are presented.

Complete the worksheet for C Fashions for the month ended December 31, 2019.

Table (1)

To determine

Prepare income statement for C Fashions for the month of December 31, 2019.

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operation and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Prepare an income statement for C Fashions for the month ended December 31, 2019.

C Fashions
Income Statement
For the Month Ended December 31, 2019
Particulars	Amount ($)	Amount ($)
Revenues:
Fees Income		82,500
Expenses:
Supplies Expense	3,600
Insurance Expense	2,400
Salaries Expense	11,100
Depreciation Expense, Machinery	1,200
Utilities Expense	1,680
Total expenses		19,980
Net income		$62,520

Table (2)

To determine

Prepare statement of owners’ equity for C Fashions for the month of December 31, 2019.

Explanation of Solution

Statement of owners’ equity: This statement reports the beginning owner’s equity and all the changes which led to ending owners’ equity. Additional capital, net income from income statement is added to, and drawings are deducted from beginning owner’s equity to arrive at the end result, ending owner’s equity.

Prepare a statement of owners’ equity for C Fashions for the month ended December 31, 2019.

C Fashions
Statement of Owners’ Equity
For the Month Ended December 31, 2019
Particulars	Amount ($)	Amount ($)
HK, Capital, December 1, 2019		$74,580
Net income for December	62,520
Less: Withdrawals for December	6,000
Increase in capital		56,520
HK, Capital, December 31, 2019		$131,100

Table (3)

To determine

Prepare balance sheet for C Fashions for the month of December 31, 2019.

Explanation of Solution

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and owners (owners’ equity) over those resources. The resources of the company are assets which include money contributed by owners and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and owners’ equity.

Prepare the balance sheet for C Fashions as at December 31, 2019.

C Fashions
Balance Sheet
December 31, 2019
Assets	Amount ($)	Amount ($)
Cash		$40,800
Accounts Receivable		9,000
Supplies		3,600
Prepaid Insurance		8,400
Machinery	$84,000
Less: Accumulated Depreciation	1,200	82,800
Total Assets		$144,600
Liabilities and owner’s equity
Liabilities
Accounts Payable		13,500
Owners’ Equity
HK, Capital		131,100
Total Liabilities and Owners’ Equity		$144,600

Table (4)

To determine

Prepare adjusting entry for the given transactions in general ledger.

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 owners’ or stockholders’ equity) to maintain the records according to accrual basis principle and matching concept.

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Prepare adjusting entry for supplies.

GENERAL JOURNAL				Page 3
Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2019	Supplies expense		3,600
	Supplies			3,600
	(To record supplies used)

Table (5)

Description:

• Supplies Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Supplies are an asset account. Since amount of supplies is used, asset account decreased, and a decrease in asset is credited.

Prepare adjusting entry for insurance expense:

GENERAL JOURNAL				Page 3
Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2019	Insurance expense		2,400
	Prepaid Insurance			2,400
	(To record part of prepaid insurance expired)

Table (6)

Description:

• Insurance Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Prepaid Insurance is an asset account. Since amount of insurance is expired, asset account decreased, and a decrease in asset is credited.

Prepare adjusting entry for depreciation expense-Machinery:

GENERAL JOURNAL				Page 3
Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
December 31, 2019	Depreciation expense-Machinery		1,200
	Accumulated depreciation-Machinery			1,200
	(To record depreciation expense)

Table (7)

Description:

• Depreciation Expense, Machinery is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Accumulated Depreciation, Machinery is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.

To determine

Prepare closing entries for the given transactions in general ledger.

Explanation of Solution

Closing entries: The journal entries prepared to close the temporary accounts to capital account are referred to as closing entries. The revenue, expense, and drawing accounts are referred to as temporary accounts because the information and figures in these accounts is held temporarily and consequently transferred to permanent account at the end of accounting year.

Steps in closing procedure:

1. 1. Close the revenue accounts to Income Summary account.
2. 2. Close the expense accounts to Income Summary account.
3. 3. Close the Income Summary account and transfer the net income or net loss balance to the Capital account.
4. 4. Close the Drawing account to Capital account.

Close the revenue accounts to Income Summary account.

GENERAL JOURNAL						Page 4
Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
2019		Fees Income			82,500
December	31		Income Summary			82,500
		(Record closing of revenue to Income Summary account)

Table (8)

Description:

• Fees income is a revenue account. Revenue account has a normal credit balance. Since revenue is closed to Income Summary account, the account is debited.
• Income Summary is a clearing account which closes revenue, expense, drawings, and net of revenues and expenses to capital accounts. The account is credited to hold the transferred balance from revenue account.

Close the expense accounts to Income Summary account.

GENERAL JOURNAL						Page 4
Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
2019		Income Summary			19,980
December	31		Supplies Expense			3,600
			Insurance Expense			2,400
			Salaries Expense			11,100
			Depreciation Expense, Machinery			1,200
			Utilities Expense			1,680
		(Record closing of expenses to Income Summary account)

Table (9)

Description:

• Income Summary is a clearing account which closes revenue, expense, drawings, and net of revenues and expenses to capital accounts. The account is debited to hold the transferred balance from expense accounts.
• Supplies Expense, Insurance Expense, Salaries Expense, Depreciation Expense, and Utilities Expense are expense accounts. Expense account has a normal debit balance. Since expenses are closed to Income Summary account, the accounts are credited.

Close the net income to Income Summary account.

GENERAL JOURNAL						Page 4
Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
2019		Income Summary			62,520
December	31		HK, Capital			62,520
		(Record closing of net income to capital account)

Table (10)

Description:

• Income Summary is a clearing account which closes revenue, expense, drawings, and net of revenues and expenses to capital accounts. Since net income is closed, the account is reversed; hence, the Income Summary account is debited.
• HK, Capital is a capital account. Since net income is transferred to the account, the value increased, and an increase in capital is credited.

Working Note 1:

Compute net income.

$\begin{array}{c}\text{Net income = Revenue–Expenses}\\ \text{=\$82,500–\$19,980}\\ \text{=\$62,520}\end{array}$

Close the Drawing account to Capital account.

GENERAL JOURNAL						Page 4
Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
2019		HK, Capital			6,000
December	31		HK, Drawing			6,000
		(Record closing of drawing to capital account)

Table (11)

Description:

• HK, Capital is a capital account. Since drawings are transferred to the account, the value decreased, and a decrease in capital is debited.
• HK, Drawing is a capital account. Since drawings are transferred, the account is credited to reverse the previously debited effect.

To determine

Prepare a post-closing trial balance for C Fashions at December 31, 2019.

Explanation of Solution

Post-closing trial balance: Post-closing trial balance is a summary of all the assets, liabilities, and capital accounts and their balances, after the closing entries are prepared. So, post-closing trial balance reports the balances of permanent accounts only.

Prepare a post-closing trial balance for C Fashions at December 31, 2019.

C Fashions Post- closing Trial Balance December 31, 2019
Account Title	Debit ($)	Credit ($)
Cash	40,800
Accounts Receivable	9,000
Supplies	3,600
Prepaid Insurance	8,400
Machinery	84,000
Accumulated Depreciation		1,200
Accounts Payable		13,500
HK, Capital		131,100
Total	145,800	145,800

Table (12)

Analyze: If expired insurance is wrongly adjusted as a credit to insurance expense and a debit to prepaid insurance for $2,400, then the net income would be increased by $4,800. The amount of net income would be reported as $67,320$\left(\$62,520+\$4,800\right)$.