Chapter 4, Problem 4.2.1AAP

To determine

Introduction: Each financial transaction or economic event will affect either assets, liabilities, or owners’ equity. Thus, the basis for recording the transaction in the accounting system depends on the accounting equation. The accounting equation is:

  $\text{Assets}\text{=}\text{Liabilities}\text{+}\text{Stockholder's}\text{Equity}$

Adjustments: Accrual basis accounting requires a number of adjustments at the end of the period. The adjustment is made for unearned revenue, accrued expenses, revenue received in advance and prepaid expenses.

To identify and analyze: The necessary adjustments for each of the preceding situation on December 31, 2017.

Explanation of Solution

1. Adjustment for the office furniture purchased last year

Activity:Operating

Accounts:Accumulated Depreciation − Furniture. Increase

Depreciation expense − Furniture. Increase

Statements:Balance sheet and Income statement.

Balance sheet	Income Statement
Assets =	Liability +	Stockholders’ equity	Revenues -	Expenses =	Net income
Accumulated Depreciation − Furniture ($3,000)		($3,000)		Depreciation Expense − Furniture $3,000	($3,000)

The depreciation for the year is calculated as follows:

  $\begin{array}{c}\text{Depreciation}=\frac{\text{cost}\text{of}\text{Asset}-\text{salvage}\text{value}}{\text{useful}\text{life}}\\ =\frac{\$25,000-\$4,000}{7}\\ =\$3,000\end{array}$

2. Adjustment for supplies used during the year

Activity:Operating

Accounts:Supplies. Decrease

Supplies expense. Increase

Statements:Balance sheet and Income statement

Balance sheet	Income Statement
Assets =	Liability +	Stockholders’ equity	Revenues -	Expenses =	Net income
Supply inventory ($13,200)		($13,200)		Supply expenses $13,200	($13,200)

Supplies consumed during the year:

Particular	Amount ($)
Supplies in hand on January 1, 2017	1,200
Supplies purchased during the year	12,900
Less: Supplies in hand at the end of December 31, 2017	(900)
Supplies consumed	13,200

3. Adjustments for customer paid in advance.

Activity:Operating

Accounts:Customer deposits in advance. Decreases.

Revenue. Increase

Statements:Balance sheet and Income statement.

Balance sheet	Income Statement
Assets=	Liability +	Stockholders’ equity	Revenues -	Expenses =	Net income
	Customer deposit in advance ($6,600)	$6,600	$6,600		$6,600

Customer deposits for $8,800 received on July 1, 2017, to be used for eight months.

As O enterprises close accounts in December every year. Hence deposits of six months from July to December will be recognized during the year:

  $\begin{array}{c}\text{Revenue}\text{recognized}=\text{total}\text{deposit}\times \frac{\text{months}\text{during}\text{the}\text{year}}{\text{total}\text{month}}\\ =\$8,800\times \frac{6}{8}\\ =\$6,600\end{array}$

4. Adjustment for prepaid rent.

Activity:Operating

Accounts:Prepaid rent. Decreases

Rent expense. Increases

Statements:Balance sheet and income statement.

Balance sheet	Income Statement
Assets =	Liability +	Stockholders’ equity	Revenues -	Expenses =	Net income
Prepaid rent ($16,000)		($16,000)		Rent expense $16,000	($16,000)

O rented warehouse on September 1, 2017, with six-month prepaid rent. As the accounts are closed in December, the rent of September to December will be recognized during the year. The rent expense is calculated as follows:

  $\begin{array}{c}\text{Rent}\text{expense}=\text{rent}\text{expense}\text{per}\text{month}\times \text{number}\text{of}\text{months}\\ =\$4,000\times 4\\ =\$16,000\end{array}$

5. Adjustment for Notes payable

Activity:Financing

Accounts:Interest payable. Increases

Interest expense. Increases

Statements:Balance sheet and Income Statement.

Balance sheet	Income Statement
Assets =	Liability +	Stockholders’ equity	Revenues -	Expenses =	Net income
	Interest payable $300	($300)		$300	($300)

90 days note taken for $30,000 at 6 percent interest payable at maturity in November. Hence interest for only the first two months will be taken for the year. The interest expense is calculated as follows:

  $\begin{array}{c}\text{Interest}\text{expense}=\text{principal}\times \text{interest}\text{rate}\times \text{period}\text{of}\text{maturity}\times \frac{\text{no}\text{.}\text{of}\text{days}\text{used}}{\text{total}\text{days}\text{till}\text{maturity}}\\ =\$30,000\times \frac{6}{100}\times \frac{90}{360}\times \frac{60}{90}\\ =\$300\end{array}$

6. Adjustment for wages payable

Activity:Operating

Accounts:Wages payable. Increases

Wages expense. Increases

Statements:Balance sheet and Income statement.

Balance sheet	Income Statement
Assets =	Liability +	Stockholders’ equity	Revenues -	Expenses =	Net income
	Wages payable $830	($830)		$830	($830)

Wages are paid every Thursday and month-end is Sunday. Therefore, the wages expense of one day (Friday) will be adjusted. The amount of wages expenses is calculated as follows:

  $\begin{array}{c}\text{Wages}\text{expense}=\text{total}\text{wages}\times \frac{\text{days}\text{worked}\text{in}\text{week}}{\text{total}\text{working}\text{days}}\\ =\$4,150\times \frac{1}{5}\\ =\$830\end{array}$