Chapter 2, Problem 2.7P

Adjusting entries and income effects

• LO2–2, LO2–5

The information necessary for preparing the 2018 year-end adjusting entries for Vito’s Pizza Parlor appears below. Vito’s fiscal year-end is December 31.

a. On July 1, 2018, purchased $10,000 of IBM Corporation bonds at face value. The bonds pay interest twice a year on January 1 and July 1. The annual interest rate is 12%.

b. Vito’s depreciable equipment has a cost of $30,000, a five-year life, and no salvage value. The equipment was purchased in 2016. The straight-line depreciation method is used.

c. On November 1, 2018, the bar area was leased to Jack Donaldson for one year. Vito’s received $6,000 representing the first six months’ rent and credited deferred rent revenue.

d. On April 1, 2018, the company paid $2,400 for a two-year fire and liability insurance policy and debited insurance expense.

e. On October 1, 2018, the company borrowed $20,000 from a local bank and signed a note. Principal and interest at 12% will be paid on September 30, 2019.

f. At year-end, there is a $1,800 debit balance in the supplies (asset) account. Only $700 of supplies remain on hand.

Required:

1. Prepare the necessary adjusting journal entries at December 31, 2018.

2. Determine the amount by which net income would be misstated if Vito’s failed to record these adjusting entries. (Ignore income tax expense.)