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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Adjusting Entries Sarah Company’s trial balance on December 31 (the end of its annual accounting period), included the following account balances before adjustments:

Chapter 3, Problem 3P, Adjusting Entries Sarah Companys trial balance on December 31 (the end of its annual accounting

Reviewing the company’s recorded transactions and accounting records, you find the following data pertaining to the December 31 adjustments:

  1. 1. On July 2, the company had accepted a $10,000, 9-month, 10% (annual rate) note receivable from a customer. The interest is to be collected when the note is collected.
  2. 2. On August 2, the company had paid $3,000 for a 2-year insurance policy.
  3. 3. The building was acquired 10 years ago and is being depreciated using the straight-line method over a 25-year life. It has an estimated residual value of $8,000.
  4. 4. The delivery equipment was purchased on April 2. It is to be depreciated using the straight-line method over a 10-year life, with an estimated residual value of $2,000.
  5. 5. On September 1, the company had received 2 years’ rent in advance ($4,320) for a portion of a building it is renting to Victoria Company.
  6. 6. On December 1, the company had issued a $7,200, 3-month, 12% (annual rate) note payable to a supplier. The interest is to be paid when the note is paid.
  7. 7. On January 2, the company purchased $1,000 of office supplies. A physical count on December 31 revealed that there are $400 of office supplies still on hand. No supplies were on hand at the beginning of the year.

Required:

Prepare the adjusting entries that are necessary to bring Sarah’s accounts up to date on December 31. Each journal entry explanation should summarize your calculations.

To determine

Prepare the adjusting entries to record the given transactions, and show the necessary calculation.

Explanation

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.

1. Prepare an adjusting entry to record the interest revenue earned at the end of the year.

DateAccount Title and Explanation

Debit

($)

Credit

($)

December 31Interest receivable500 
     Interest revenue 500
 (To record the interest revenue earned at the end of the accounting year)  

Table (1)

  • Interest receivable is an asset account, and it increases the value of asset. Hence, debit the interest receivable account with $500.
  • Interest revenue is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the interest revenue with $500.

Working note (1):

Calculate the value of interest revenue.

Interest revenue=[Note receivable×Interest rate×(Number of months interest accruedMonths in a year)]=$10,000×10100×612(July 2 to December 31)=$500

2. Prepare the adjusting entry for the overstated insurance expense.

DateAccount Title and Explanation

Debit

($)

Credit

($)

December 31Prepaid insurance (2)2,375 
 Insurance expense 2,375
 (To adjust the overstated insurance expense at the end of the accounting year)  

Table (2)

  • Prepaid insurance is an asset account, and it increases the value of assets. Hence, debit the prepaid insurance account with $2,375.
  • Insurance expense is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the insurance expense with $2,375.

Working note (2):

Calculate the value of overstated insurance expense.

Overstated insurance expense = (Value of policy × [Number of months left Number of months policy covered])=$3,000×19 months 24 months=$2,375

Note: Number of months left in insurance policy is 19 months (24 months 5 months), as 5 months (August 1 to December 31) is covered during the current year.

3. Prepare an adjusting entry to record the depreciation expense incurred at the end of the year.

DateAccount Title and Explanation

Debit

($)

Credit

($)

December 31Depreciation expense2,080 
 Accumulated depreciation-Building (3) 2,080
 (To record the depreciation expense incurred at the end of the accounting year)  

Table (3)

  • Depreciation expense-Building is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the depreciation expense with $2,080.
  • Accumulated depreciation-Building is a contra-asset account, and it decreases the value of assets. Hence, credit the accumulated depreciation expense with $2,080.

Working note (3):

Calculate the depreciation expense on building.

Depreciation expense on building} = Cost of buildingResidual valueUseful life of the assets=$60,000$8,00025 years=$2,080

4. Prepare an adjusting entry to record the depreciation expense incurred at the end of the year.

DateAccount Title and Explanation

Debit

($)

Credit

($)

December 31Depreciation expense900 
 Accumulated depreciation-Delivery equipment (4) 900
 (To record the depreciation expense incurred at the end of the accounting year)  

Table (4)

  • Depreciation expense-Delivery equipment is component of shareholders’ equity, and it decreases the value of shareholders equity

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