Chapter 3, Problem 3.2APR

A.

To determine

Adjusting entries:

Adjusting entries refers to the entries that are made at the end of an accounting period in accordance with revenue recognition principle, and expenses recognition principle.  All adjusting entries affect at least one income statement account (revenue or expense), and one balance sheet account (asset or liability).

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Accrual basis of accounting:

Accrual basis of accounting refers to recognizing the financial transactions during the period in which the event occurs, even if the cash is not exchanged.

Income statement:

This is the financial statement of a company which shows all the revenues earned and expenses incurred by the company over a period of time.

Balance sheet:

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

To prepare: The adjusting entries in the books of Company AC at the end of the year.

Explanation of Solution

An adjusting entry for accrued fees:

In this case, the Company AC recognized the fees at the end of the year. So, the necessary adjusting entry that the business should record for the accrued at end of the year is as follows:

Date		Description	Post. Ref	Debit ($)	Credit ($)
July	31	Accounts receivable		11,150
		Fees earned			11,150
		(To record the fees earned at end of the year)

Table (1)

• Account receivable is an asset, and it increased the value of asset by $11,150, hence debit the accounts receivable for $11,150. 
• Fees earned increased the value of stockholders’ equity by $11,150; hence credit the fees earned for $11,150.

An adjusting entry for Supplies expenses:

In this case, Company AC recognized the supplies expenses at the end of the year. So, the necessary adjusting entry that the Company AC should record to recognize the supplies expense is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
July	31	Supplies expenses  (1)		2,450
		Supplies			2,450
		(To record the supplies expenses incurred at the end of the year)

Table (2)

Working note:

Calculate the value of supplies expense

$\begin{array}{c}\text{Supplies}\text{expense}\text{=}\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{supplies}\\ \text{begining of the year}\end{array}\right)-\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{supplies}\text{on}\text{hand}\\ \text{at}\text{the}\text{end}\text{of}\text{the year}\end{array}\right)\\ =\left(\$3,350–\$900\right)\\ =\$2,450\end{array}$ (1)

• Supplies expense decreased the value of stockholders’ equity by $2,450; hence debit the supplies expenses for $2,450.
• Supplies are an asset, and it decreased the value of asset by $2,450, hence credit the supplies for $2,450.  

An adjusting entry for rent expenses:

In this case, Company AC recognized the rent expenses at the end of the year. So, the necessary adjusting entry that the Company AC should record to recognize the prepaid expense is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
July	31	Rent expenses		6,000
		Prepaid rent			6,000
		(To record the rent expenses incurred at the end of the year)

Table (3)

• Rent expense decreased the value of stockholders’ equity by $6,000; hence debit the rent expenses for $6,000.
• Prepaid rent is an asset, and it decreased the value of asset by $6,000, hence credit the prepaid rent for $6,000.  

An adjusting entry for depreciation expenses:

In this case, Company AC recognized the depreciation expenses at the end of the year. So, the necessary adjusting entry that the Company AC should record to recognize the accrued expense is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
July	31	Depreciation expenses		8,950
		Accumulated depreciation-Equipment			8,950
		(To record the depreciation expenses incurred at the end of the year)

Table (4)

• Depreciation expense decreased the value of stockholders’ equity by $8,950; hence debit the depreciation expenses for $8,950.
• Accumulated depreciation is a contra-asset account, and it decreased the value of asset by $8,950, hence credit the accumulated depreciation for $8,950.  

An adjusting entry for unearned fees revenue:

In this case, Company AC received cash in advance before the service provided to customer. So, the necessary adjusting entry that the Company AC should record for the unearned fees revenue at the end of the year is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
July	31	Unearned fees revenue		10,000
		Fees earned (2)			10,000
		(To record the unearned fees revenue at the end of the year)

Table (5)

Working note:

Calculate the value of accrued wages at end of the October

$\begin{array}{c}\text{Fees earned}\text{=}\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{unearned fees}\\ \text{at the begining of the year}\end{array}\right)-\left(\begin{array}{l}\text{The}\text{amount}\text{of}\text{unearned fees}\\ \text{at}\text{the}\text{end}\text{of}\text{the year}\end{array}\right)\\ =\left(\$12,000–\$2,000\right)\\ =\$10,000\end{array}$ (2)

• Unearned fees revenue is a liability, and it decreased the value of liability by $10,000, hence debit the unearned fees revenue for $10,000.
• Fees earned increased stockholders’ equity by $10,000; hence credit the fees earned for $10,000.

An adjusting entry for wages expenses:

In this case, Company AC recognized the wages expenses at the end of the year. So, the necessary adjusting entry that the Company AC should record to recognize the accrued expense is as follows:

Date		Description	Post Ref.	Debit ($)	Credit ($)
July	31	Wages expenses		4,840
		Wages payable			4,840
		(To record the wages expenses incurred at the end of the year)

Table (6)

• Wages expense decreased the value of stockholders’ equity by $4,840; hence debit the wages expenses for $4,840.
• Wages payable is a liability, and it increased the value of liability by $4,840, hence credit the wages payable for $4,840.  

B.

To determine

The effects on the income statement, if adjusting entries are not recorded.

Answer to Problem 3.2APR

The effects on the income statement, if the adjusting entries are not recorded are as follows:

Adjustment Not Recorded	Income Statement
	Revenue	Expenses	Net income
Unbilled fees	Understated by $11,150		Understated by $11,150
Accrued wages		Understated by $4,840	Overstated by $4,840

Table (7)

Explanation of Solution

Accrued fees (unbilled fees)

Given entry would increase the fees earned account, and increase the accounts receivable account, if adjusting entry for accrued fees is not recorded, and it will affect two accounts such as fees earned (revenue), and accounts receivable (asset). Hence the fees of $11,150 has been understated the value of total revenue of the Company AC, and it understated the value of net income by $11,150.

Accrued wages

Given entry would increase the wages expense account, and increase the wages payable account, if adjusting entry for accrued wages is not recorded, and it will affect two accounts such as wages expense (expense), and wages payable (liability). Hence the wages expense of $4,840 has been understated the value of total expense of the Company AC, and it overstated the value of net income by $4,840.

Conclusion

Hence, the revenues of the Company AC were understated by $11,150, and the expenses were understated by $4,840. Thus, the net income of Company AC was understated by $6,310 $\left(\$11,150-\$4,840\right)$.

C.

To determine

The effects on the balance sheet, if adjusting entries are not recorded.

Answer to Problem 3.2APR

The effects on the balance sheet, if the adjusting entries are not recorded are as follows:

Adjustment Not Recorded	Balance Sheet
	Assets	Liabilities	Stockholders’ Equity
Unbilled fees	Understated by $11,150		Understated by $11,150
Accrued wages		Understated by $4,840	Overstated by $4,840

Table (8)

Explanation of Solution

Accrued fees (unbilled fees)

Given entry would increase the fees earned account, and increase the accounts receivable account, if adjusting entry for accrued fees is not recorded, and it will affect two accounts such as fees earned (revenue), and accounts receivable (asset). Hence the fees earned of $11,150 has been understated the value of assets of the Company AC, and understated accrued fees understates the stockholders’ equity by $11,150.

Accrued wages

Given entry would increase the wages expense account, and increase the wages payable account, if adjusting entry for accrued wages is not recorded, and it will affect two accounts such as wages expense (expense), and wages payable (liability). Hence the wages expense of $4,840 has been understated the value of liabilities of the Company AC, and understated accrued wages overstates the stockholders’ equity by $4,840.

Conclusion

Hence, the assets of the Company AC were understated by $11,150, and the liabilities were understated by $4,840. Thus, the total liabilities ($4,840) and owner’s equity ($6,310) of Company AC was understated by $11,150 $\left(\$4,480+\$6,310\right)$.

D.

To determine

The effects on the “net increase or decrease in cash” on the statement of cash flow, if adjusting entries are not recorded.

Explanation of Solution

There is no effect on the “net increase or decrease in cash” on the statement of cash flow because, the adjusting entries are prepared in accordance with the accrual basis of accounting. Hence, adjusting entries do not effect the cash flow statement of the company.