Chapter 7, Problem 7BP

a.

To determine

Prepare adjusting journal entries that arise due to bank reconciliation for Incorporation DM as on December 31, Year 1.

Explanation of Solution

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 journal entries that arise due to bank reconciliation for Incorporation DM as on December 31, Year 1.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
December	31	Bank Service Charges			125
		Accounts Receivable			2,350
		Office Supplies			962
			Cash			3,437
		(Record payment of bank service charges, NSF check, and increase office supplies)

Table (1)

Description:

• Bank Service Charges is an expense account and the amount is increased because bank has charged service charges. Expenses decrease Equity account and decrease in Equity is debited.
• Accounts Receivable is an asset account. The bank has not collected the amount from the customer due to insufficient funds, which was earlier recorded as a receipt. As the collection could not be made, amount to be received increased. Therefore, increase in asset would be debited.
• Office Supplies is an asset account. The asset amount was erroneously recorded, and so cash balance increased. Hence, cash value is decreased by crediting and Office Equipment account is debited.
• Cash is an asset account. The amount is decreased because bank service charge is paid, bank could not collect cash due to insufficient funds in customer’s account, office supplies is paid, and a decrease in asset and asset is decreased.

b.

To determine

Prepare journal entry for adjusting the marketable securities to the fair market value, as on December 31, Year 1.

Explanation of Solution

Prepare journal entry for adjusting the marketable securities to the fair market value, as on December 31, Year 1.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
December	31	Marketable Securities			7,000
			Unrealized Holding Gain on Investments			7,000
		(Record the adjustment of cost of investment to the fair value)

Table (2)

Description:

• Marketable Securities is an asset account. The account is debited because the market price was increased, and eventually the asset value increased.
• Unrealized Holding Gain on Investments is an adjustment account used to report gain or loss on adjusting cost of investment at fair market value. Since gain has occurred and gains increase stockholders’ equity value, an increase in stockholders’ equity value is credited.

Working Notes:

Determine the unrealized gain or loss on investment on December 31, Year 1.

$\begin{array}{c}\begin{array}{l}\text{Unrealized holding }\\ \text{gain or }\left(\text{loss}\right)\end{array}\}\text{= }\left\{\begin{array}{l}\text{Fair value of investment on December 31– }\\ \text{Cost of investment}\end{array}\right\}\\ \text{=\$75,000–\$68,000}\\ \text{=\$7,000}\end{array}$

c.

To determine

Journalize the adjustment entry of accrued interest revenue on December 31, Year 1.

Explanation of Solution

Journalize the adjustment entry of accrued interest revenue on December 31, Year 1.

Date		Accounts and Explanation		Post Ref.	Debit ($)	Credit ($)
Year 1
December	31	Interest Receivable			360
			Interest Revenue			360
		(Record accrued interest on note)

Table (3)

Description:

• Interest Receivable is an asset account. Since interest to be received has increased, asset value increased, and an increase in asset is debited.
• Interest Revenue is a revenue account. Since revenues increase equity, equity value is increased, and an increase in equity is credited.

Working Notes:

Compute amount of interest accrued on December 31, Year 1.

$\begin{array}{c}\text{Interest accrued = }\left\{\begin{array}{l}\text{Principal amount of note × }\\ \text{Rate of interest×}\\ \text{Time period}\left(\text{Monthly interest}\right)\end{array}\right\}\\ \text{= \$72,000×6\%×}\frac{1}{\text{12}}\\ \text{= \$360}\end{array}$

d.

To determine

Journalize the uncollectible accounts expense transaction, if credit balance of Allowance for Doubtful Accounts is $1,400 prior to adjustments.

Explanation of Solution

Journalize the uncollectible accounts expense transaction, if credit balance of Allowance for Doubtful Accounts is $8,000 prior to adjustments.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
		Uncollectible Accounts Expense			49,000
			Allowance for Doubtful Accounts			49,000
		(Record uncollectible accounts expense)

Table (4)

Description:

• Uncollectible Accounts Expense is an expense account. Since expenses and losses decrease the equity and an increase in equity is debited, so, Uncollectible Accounts Expense account is debited.
• Allowance for Doubtful Accounts is a contra-asset account to Accounts Receivable account. The contra-asset accounts decrease the asset value, and a decrease in asset is credited.

Working Notes:

Compute the Uncollectible Accounts Expense value.

Step 1: Compute the Allowance for Doubtful Accounts beginning balance.

Details	Amount ($)
Accounts receivable	$900,000
Net realizable value	(860,000)
Allowance for Doubtful Accounts balance	$40,000

Table (5)

Step 2: Compute the Uncollectible Accounts Expense value.

Details	Amount ($)
Debit balance prior to adjustment	$9,000
Credit adjustment required	49,000
Credit balance required	$40,000

Table (6)

Note: Refer to Table (5) for value and computation of credit balance required.

e.

To determine

Discuss the effect of reporting the net realizable value on accounts receivable turnover rate, and explain whether the effect of written off accounts receivable on accounts receivable turnover rate has the same effect of reporting the net realizable value on accounts receivable turnover rate.

Explanation of Solution

Net realizable value: The value of accounts receivables that could be recognized by the company is referred to as net realizable value. In simple words, net realizable value is accounts receivables, less allowance of uncollectible amount.

Accounts receivable turnover: This is the ratio which analyzes the number of times accounts receivables is collected and converted into cash during the period. This ratio gauges the efficacy of collecting receivables. Larger the ratio, more efficient in collecting receivables.

Effect of reporting the net realizable value on accounts receivable turnover rate: Since the uncollectible accounts expense decreases the net realizable value of accounts receivable, the accounts receivable turnover increases.

Effect of written off accounts receivable on accounts receivable turnover rate: As the write-off of accounts receivable has no effect on net realizable value of accounts receivable, the accounts receivable turnover remains the same. So, the written off accounts receivable does not have the same effect on accounts receivable turnover rate as the reporting of the net realizable value has on accounts receivable turnover rate.