Chapter 3, Problem 6BTN

1.

To determine

Explanation of Solution

• Expense account will be debited because it reduces equity.
• Prepaid expense account is an asset account. Since, some of the prepaid expense is used up, it decreases asset. Hence, credit prepaid expense account.
• According to matching concept, it is necessary to take in account all expenses and revenue of the same period for calculating profit. Hence, it is necessary to make an adjustment.

Hence, it reduces asset and increase expense.

a.

To determine

To explain: Description of the adjustment and why it is necessary.

Explanation of Solution

• Expense account will be debited because it reduces equity.
• Prepaid expense account is an asset account. Since, some of the prepaid expense is used up, it decreases asset. Hence, credit prepaid expense account.
• According to matching concept, it is necessary to take in account all expenses and revenue of the same period for calculating profit. Hence, it is necessary to make an adjustment.

Hence, it reduces asset and increase expense.

b.

To determine

To prepare: Example of a transaction that requires adjustment.

Explanation of Solution

Insurance payment made in advance on October 1, 2017 of $7,200. The period of policy is 3 months starting from October 1.

c.

To determine

To prepare: Adjusting entry

Explanation of Solution

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
December 31	Insurance expense		7,200
	Prepaid insurance			7,200
	(Being prepaid insurance is adjusted)
Table (1)

• Insurance expense is an expense. Since, expense reduces equity, debit insurance expense account.
• Prepaid Insurance is an asset. Since, the insurance used up, it reduces asset. Hence, credit prepaid insurance account.

d.

To determine

To explain: Status of the affected accounts before and after the adjustments.

Explanation of Solution

• Before the adjustment, prepaid insurance account is debited with $7,200 because payment is made in advance and it increases asset.
• After the adjustment, insurance expense account is debited, because expense reduces equity; and prepaid insurance account is credited with $7,200 because the period is exhausted and it decreases asset.

Hence, before adjustment prepaid account was debited with excess balance after adjustment it shows fair view.

e.

To determine

To explain: Effects on financial statement of not making adjustment.

Explanation of Solution

• Without passing adjusting entry, it will not show an expense because expense is still treated as an asset. Hence, income statement will show a higher profit.
• Without passing journal entry, asset will show a higher balance because expense is still treated as an asset.

Hence, it will show higher net income and higher balance of balance sheet.

(2)

a.

To determine

To explain: Description of the adjustment and why it is necessary.

Explanation of Solution

• Unearned revenue is a liability. Since, services will be provided by then, it decreases liability. Hence, debit unearned revenue account.
• Revenue earned is revenue. Since, money will be earned by then, it increases income. Hence, credit revenue earned account.

Hence, it is necessary to show the true and fair view of financial statement.

b.

To determine

To prepare: Example of a transaction that requires adjustment.

Explanation of Solution

Payment received in advance for a work on October 1, 2017 worth $7,000.

c.

To determine

To prepare: Adjusting entry.

Explanation of Solution

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
December 31	Unearned revenue		7,000
	Revenue earned			7,000
	(Being work performed for money received in advance
Table (2)

• Unearned revenue is a liability. Since, services is provided, it decreases liability. Hence, debit unearned revenue account.
• Revenue earned is revenue. Since, service is provided, it increases revenue. Hence, credit revenue earned account.

d.

To determine

To explain: Status of the affected accounts before and after the adjustments.

Explanation of Solution

• Before the adjustment, unearned revenue account is credited with $7,000 because money is received for the work which was not performed yet
• After the adjustment, unearned revenue account is debited with $7,000, because work is now performed and it decreases liability. Revenue earned account is credited with $7,000 because work is performed and money is earned, it increases revenue.

Hence, unearned revenue account is debited and revenue earned account is credited.

e.

To determine

To explain: Effects on financial statement of not making adjustment.

Explanation of Solution

• Without passing adjusting entry, there will be no revenue earned account and it will decrease profit of the firm.
• Without passing journal entry, liability will show a higher balance because revenue is still showing unearned and it increases liability.

Hence, it will show higher balance of liability.

(3)

a.

To determine

To explain: Description of the adjustment and why it is necessary.

Explanation of Solution

• Expense account will be debited because expense reduces equity.
• Expense payable account will be credited because expense is due but not paid, it increases liability.

Hence, expense and expense payable account will increase and it is make to show fair view.

b.

To determine

To prepare: Example of a transaction that requires adjustment.

Explanation of Solution

Payment of salary takes place on weekly basis with payment on every next Monday. December month ends on Monday, now 1 day salary is not paid. Daily salary is $500.

c.

To determine

To prepare: Adjusting entry.

Explanation of Solution

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
December 31	Salary expense		500
	Salary Payable			500
	(Being work performed for money received in advance
Table (3)

• Salary expense is an expense. Since, expense reduces equity, debit salary expense account.
• Salary Payable is a liability. Since, expense has occurred but not paid yet, it increases liability. Hence, credit salary payable account.

d.

To determine

To explain: Status of the affected accounts before and after the adjustments.

Explanation of Solution

• Before the adjustment, salary expense and salary payable account was not showing any balance because the transaction was not recorded yet.
• After the adjustment, salary expense account is debited, because salary is become due and it increases expense. Salary payable is a liability. Since, salary is not paid, it increases liability. Hence, credit salary payable account.

Hence, salary expense balance will increase and liability will increase.

e.

To determine

To explain: Effects on financial statement of not making adjustment.

Explanation of Solution

• Without passing adjusting entry, it will not show an expense because there is no entry to show any effect. Hence, income statement will show a higher profit.
• Without passing journal entry, liability will show a lower balance because there is no entry to show liability.

Hence, it will show lower balance of liability.

(4)

a.

To determine

To explain: Description of the adjustment and why it is necessary.

Explanation of Solution

• Accounts receivable is an asset. Since income is earned but not received yet, it increases asset. Hence, debit revenue receivable account.
• Revenue earned is an income. Since money is earned, income is increased. Hence, credit revenue earned account.

Hence, accounts receivable and revenue earned will increase.

b.

To determine

To prepare: Example of a transaction that requires adjustment.

Explanation of Solution

Storage services is provided worth $1,000 on 1 December but not received yet

c.

To determine

To prepare: Adjusting entry

Explanation of Solution

Date	Particulars	Post ref	Debit($)	Credit($)
December 31	Accounts Receivable		1,000
	Storage fees earned			1,000
	(Being storage fees earned but not received yet)
Table (4)

• Accounts receivable is an asset. Since income is earned but received yet, it increases asset. Hence, debit accounts receivable account.
• Storage fees earned are an income. Since, money is earned, income is increased. Hence, credit storage fees earned account.

d.

To determine

To explain: Status of the affected accounts before and after the adjustments.

Explanation of Solution

• Before the adjustment, accounts receivable and storage fees earned account was not showing any balance because the transaction was not recorded yet.
• After the adjustment, accounts receivable account is debited with $1,000, because income is earned but received yet, it increase asset. Storage fees earned are an income. Since money is earned, income is increased. Hence, storage fees earned account is credited with $1,000.

Hence, accounts receivable will increase and storage fees earned will increase.

e.

To determine

To explain: Effects on financial statement of not making adjustment.

Explanation of Solution

• Without passing adjusting entry, there will be no storage fees earned account and it will decrease profit of the firm.
• Without passing journal entry, asset will show a lower balance because there is no entry which means there is no record of asset.

Hence, it will show higher net income and higher balance of balance sheet.

3.

To determine

To prepare: A report on the four type of adjustment.

Explanation of Solution

Report:

On prepaid expenses:

Description of the adjustment and why it is necessary.

Adjustment will decrease prepaid expense and increase expense of the firm. It is necessary to show the true and fair view of the financial statement.

Example of a transaction that requires adjustment.

Insurance payment made in advance on October 1, 2017 of $7,200. The period of policy is 3 months starting from October 1

Adjusting entry

Date	Account Title and Explanation	Post ref	Debit($)	Credit($)
December 31	Insurance expense		7,200
	Prepaid insurance			7,200
	(Being prepaid insurance is adjusted)
Table (5)

• Insurance expense is an expense. Since, expense reduces equity, debit insurance expense account.
• Prepaid Insurance is an asset. Since, the insurance used up, it reduces asset. Hence, credit prepaid insurance account.

Status of the affected accounts before and after the adjustments.

Before the adjustment, prepaid insurance shows a higher balance than after the adjustment and insurance expense shows higher balance after adjustment than the before adjustment.

Effects on financial statement of not making adjustment.

It will show higher balance of assets and higher net income and equity if adjustment is not made.