Chapter 27, Problem 8SPB

1.

To determine

Prepare adjusting entries of Company M for the year ended December 31.

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 adjusting entries of Company M for the year ended December 31 as follows:

Date		Account Title and Explanation	Post ref.	Debit ($)	Credit ($)
December 31	a.	Work in process inventory account		4,400
		Factory overhead			4,400
		(To record the transfer of work in process inventory account to factory overhead)
December 31	b.	Sales return and allowances		700
		Customer refunds payable			700
		(To record the sales return from the customer)
December 31	c.	Estimated returns inventory		380
		Cost of goods sold			380
		(To record the expected return of cost of goods sold)
December 31	d.	Interest receivable		190
		Interest revenue			190
		(To record the interest revenue earned at the end of the accounting year)
December 31	e.	Interest Expense		1,420
		Interest Payable			1,420
		(To record the interest expense incurred at the end of the accounting year)
December 31	f.	Bad Debt Expense		3,200
		Allowance for Doubtful Accounts			3,200
		(To record the bad debt expense incurred at the end of the accounting year)
December 31	g.	Office Supplies Expense		4,200
		Office Supplies			4,200
		(To record the office supplies expense incurred at the end of the accounting year)
December 31	h.	Factory Overhead (supplies expense)		3,800
		Factory Supplies			3,800
		(To record the supplies expense incurred at the end of the accounting year)
December 31	i.	Factory Overhead (insurance expense)		6,800
		Prepaid insurance			6,800
		(To record the insurance expense incurred at the end of the accounting year)
December 31	j.	Factory overhead-(depreciation expense for factory building)		8,000
		Accumulated Depreciation-factory building			8,000
		(To record the depreciation expense incurred at the end of the accounting year)
December 31	k.	Factory Overhead (Depreciation expense-Factory Equipment)		5,000
		Accumulated Depreciation-Factory Equipment			5,000
		(To record the depreciation expense incurred at the end of the accounting year)
December 31	l.	Factory Overhead		4,340
		Cost of goods sold			4,340
		(To record the factory overhead transferred to the cost of goods sold)
December 31	m.	Income Tax Expense		6,400
		Income Tax Payable			6,400
		(To record the income tax expense incurred at the end of the account)

Table (1)

2.

To determine

Prepare closing entries of Company M for the year ended December 31.

Explanation of Solution

Closing entries: The journal entries prepared to close the temporary accounts to Retained Earnings account are referred to as closing entries. The revenue, expense, and dividends 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.

Prepare closing entries of Company M for the year ended December 31 as follows:

Date	Account Title and Explanation	Post ref.	Debit ($)	Credit ($)
December 31	Income Summary		112,500
	Factory Overhead (Subsidiary ledger account)			112,500
	(To close the subsidiary factory overheads account)
December 31	Factory Overhead		112,500
	Income Summary			112,500
	(To close the factory overhead account)
December 31	Sales		393,840
	Interest revenue		990
	Income Summary			394,830
	(To close the sales and interest revenue account)
December 31	Income Summary		329,640
	Sales return and allowances			7,250
	Cost of Goods Sold			189,970
	Wages expense			90,000
	Office supplies expense			4,200
	Bad debt expense			3,200
	Utilities expense-office			7,200
	Interest expense			10,420
	Income tax expense			17,400
	(To close all expenses account)
December 31	Income Summary		65,190
	Retained Earnings (1)			65,190
	(To close the income summary account)

Table (2)

Closing entry for factory overhead:

The total debit balance of factory overhead account is transferred to the income summary account in order to bring the debit balance of factory overhead account to zero, and in the closing entry the income summary account is debited with $112,500, and the factory overhead account is credited (subsidiary ledger account) with $112,500.

The total credit balance of factory overhead account is transferred to the income summary account in order to bring the credit balance of factory overhead account to zero, and in the closing entry the factory overhead account is debited with $112,500, and the income summary account is credited with $112,500.

Closing entry for revenue account:

In this closing entry, the sales and interest revenue account is closed by transferring the amount of sales and interest revenue to the income summary account in order to bring the all revenue accounts balance to zero.  Hence, debit the all revenue account for $394,830, and credit the income summary account for $394,830.

Closing entry for expenses account:

In this closing entry, all expenses are closed by transferring the amount of all expenses to the income summary account in order to bring all the expense accounts balance to zero. Hence, debit the income summary account for $329,640, and credit all the expenses account for $329,640.

Closing entry for income summary account:

In this closing entry, the income summary account is closed by transferring the amount of net income to the retained earnings account in order to bring the income summary balance to zero.  Hence, debit the income summary account for $65,190, and credit the retained earnings for $65,190.

Working note (1):

Calculate the value of retained earnings.

$\begin{array}{c}\text{Retained earnings =}\left(\begin{array}{l}\text{Credit balance of income summary account}-\\ \text{Debit balance of income summary account}\end{array}\right)\\ =\$394,830-\$329,640\\ =\$65,190\end{array}$

3.

To determine

Prepare the reversing entries of Company M as of January 1, 20-2.

Explanation of Solution

Reversing entries: Reversing entries are made at the beginning of the accounting period when the accountant needs to cancel any entry made in the previous accounting period. It is done in order to eliminate any errors that might have occurred in the calculation of the revenue or expenses and henceforth increase the efficiency of the financial statements for an improved decision making.

Prepare the reversing entries of Company M as of January 1, 20-2 as follows:

Reversing entry for interest revenue:

Date	Account Title and Explanation	Post ref.	Debit ($)	Credit ($)
January 1	Interest revenue		190
	Interest receivable			190
	(To record the reversing entry for interest revenue)

Table (3)

• ■ Interest revenue is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the interest revenue with $190.
• ■ Interest receivable is an asset account, and it decreases the value of asset. Hence, credit the interest receivable account with $190.

Reversing entry for interest expense:

Date	Account Title and Explanation	Post ref.	Debit ($)	Credit ($)
January 1	Interest payable		1,420
	Interest expense			1,420
	(To record the reversing entry for interest expense)

Table (4)

• ■ Interest payable is a liability account and it decreases in the value of liabilities. Hence, debit the interest payable with $1,420.
• ■ Interest expense is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the interest expense with $1,420.

Reversing entry for factory overheads:

Date	Account Title and Explanation	Post ref.	Debit ($)	Credit ($)
January 1	Factory Overhead		4,400
	Work in Process Inventory			4,400
	(To record the reversing entry for factory overhead)

Table (5)

• ■ Factory overhead (expense) is a component of owner’s equity, and there is an increase in the value of expense. Hence, debit the factory overhead account with $4,400.
• ■ Work in process inventory is an asset account, and it decreases the value of asset. Hence, credit the work in process inventory account with $4,400.