Chapter 3, Problem 5AP

To determine

Prepare the necessary adjusting entries at 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.

Rules of Debit and Credit:

Following rules are to be 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.

Accrued expense: Accrued expense is the expense incurred but not yet paid. It is treated as liability until the expense is paid. Hence, accrued expenses require adjustment at the end of the accounting period.

Accrued revenue: Accrued revenue is the revenue earned but not yet received. It is treated as asset until the cash is received. Hence, accrued revenues require adjustment at the end of the accounting period.

Prepaid expenses:

Advance payment for future expenses is called as prepaid expenses. These prepaid expenses are considered as assets until they are expensed or used. Hence, prepaid expenses require adjustment at the end of the accounting period.

Unearned revenues:

Collection of cash in advance to render service or to deliver goods in future is known as unearned revenues. These unearned revenues are considered as liabilities until they are earned. Hence, unearned revenue requires adjustment at the end of the accounting period.

1.

Prepare adjusting entry for accrued salaries expense.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
December	31	Salaries Expense		1,008
		Salaries Payable			1,008
		(To record accrued salaries for two days of December)

Table (1)

• Salaries expense is an expense account. The amount has increased because salaries are accrued and the increased expenses decrease equity value. Therefore, debit Salaries Expense account with $1,008.
• Salaries Payable is a liability account. The amount has increased because salaries that are to be paid have increased. Therefore, credit Salaries Payable account with $1,008.

Working Notes:

Compute the salaries for two days (Monday and Tuesday).

Salaries for 5 days is $2,520

Number of days is 2 days

$\begin{array}{c}\begin{array}{l}\text{Salaries for }\\ \text{two days}\end{array}\}=\frac{\text{Salaries for 5 days}}{\text{5 days}}\text{ × Number of days}\\ =\frac{\text{\$2,520}}{\text{5 days}}\text{×2 days}\\ =\$1,008\end{array}$

2.

Prepare adjusting entry for accrued interest expense.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
December	31	Interest Expense		250
		Interest Payable			250
		(To record accrued interest)

Table (2)

• Interest expense is an expense account. The amount has increased because interest is outstanding on the note is accrued and the increased expenses decrease equity value. Therefore, debit Interest Expense account with $250.
• Interest Payable is a liability account. The amount has increased because salaries that are to be paid have increased. Therefore, credit Interest Payable account with $250.

3.

Prepare adjusting entry for accrued service revenue.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
December	31	Fee Receivable		1,000
		Service Revenue			1,000
		(To record accrued earned fee revenue)

Table (3)

• Fee Receivable is an asset account. The amount has increased because services are performed but the amount is to be received. Therefore, debit Fee Receivable account with $1,000.
• Service Revenue is a revenue account. The amount has increased because service revenue is to be received and revenues increase Equity value. Therefore, credit Service Revenue account with $1,000.

4.

Prepare adjusting entry for prepaid maintenance.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
December	31	Maintenance Expense		125
		Prepaid Maintenance			125
		(To record maintenance expense)

Table (4)

• Maintenance expense is an expense. There is an increase in the expenses, and therefore debit Maintenance Expense with $125.
• Prepaid Maintenance is an asset. There is a decrease in assets, and therefore credit Prepaid Maintenance with $125.

5.

Prepare adjusting entry for prepaid maintenance.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
December	31	Advertising Expense		300
		Prepaid Advertising			300
		(To record accrued advertising expense)

Table (5)

• Advertising expense is an expense. There is an increase in the expenses, and therefore debit Advertising Expense with $300.
• Prepaid Advertising is an asset. There is a decrease in assets, and therefore credit Prepaid Advertising with $300.

Working Note:

Compute maintenance expense for December.

Prepaid advertising expense is $900

Total aired as on December 31 is One-third of $900

$\begin{array}{c}\text{Advertising expense}=\left(\begin{array}{l}\text{Prepaid advertising expense ×}\\ \text{Total aired as on December 31}\end{array}\right)\\ =\$900\times \frac{1}{3}\\ =\$300\end{array}$

6.

Prepare adjusting entry for prepaid maintenance.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
December	31	Rent Expense		160
		Prepaid Rent			160
		(To record rent expense)

Table (6)

• Rent expense is an expense. There is an increase in the expenses, and therefore debit Rent Expense with $160.
• Prepaid Rent is an asset. There is a decrease in assets, and therefore credit Prepaid Rent with $160.

Working Note:

Compute rent expense for 15 days.

Total square feet = 400 square feet

Monthly rate per square foot = $0.80

Number of days = 15 days

$\begin{array}{c}\text{Rent expense}=\frac{\left(\begin{array}{l}\text{Total square feet × }\\ \text{Monthly rate per square foot}\end{array}\right)}{\text{30 days}}\text{ × Number of days}\\ =\frac{\text{400 square feet×\$0}\text{.80}}{\text{30 days}}\text{×15 days}\\ =\frac{\text{\$320}}{\text{30 days}}\text{×15 days}\\ =\$160\end{array}$

7.

Prepare adjusting entry for deferred interest income.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
December	31	Interest Receivable		62
		Interest Income			62
		(To record accrued interest earned on securities)

Table (7)

• Interest Receivable is an asset account. The amount has increased because interest is earned on securities will be received in future. Therefore, debit Interest Receivable account with $62.
• Interest Income is a revenue account. The amount has increased because interest income is to be received and revenues increase Equity value. Therefore, credit Interest Income account with $62.

8.

Prepare adjusting entry for depreciation.

Date		Account Titles and Explanation	Post Ref.	Debit ($)	Credit ($)
December	31	Depreciation Expense		2,425
		Accumulated Depreciation –           Equipment			2,425
		(To record depreciation expense)

Table (8)

• Depreciation Expense is an expense account. Expenses decrease Equity value. Therefore, debit Depreciation Expense account with $2,425.
• Accumulated Depreciation – Equipment is a contra-asset account and would have a normal credit balance. Therefore, credit Accumulated Depreciation – Equipment account with $2,425.