Chapter 4, Problem 4.9.3MCP

Monthly Transactions, Adjustments, and Financial Statements

Moonlight Bay Inn is incorporated on January 2, 2017, by its three owners, each of whom contributes $20,000 in cash in exchange for shares of stock in the business. In addition to the sale of stock, the following transactions are entered into during the month of January:

January 2: A Victorian inn is purchased for $50,000 in cash. An appraisal performed on this date indicates that the land is worth $15,000, and the remaining balance of the purchase price is attributable to the house. The owners estimate that the house will have an estimated useful life of 25 years and an estimated salvage value of $5,000.

January 3: A two-year, 12%, $30,000 promissory note was signed at Second State Bank. Interest and principal will be repaid on the maturity date of January 3, 2019.

January 4: New furniture for the inn is purchased at a cost of $15,000 in cash. The furniture has an estimated useful life of ten years and no salvage value.

January 5: A 24-month property insurance policy is purchased for $6,000 in cash.

January 6: An advertisement for the inn is placed in the local newspaper. Moonlight Bay pays $450 cash for the ad, which will run in the paper throughout January.

January 7: Cleaning supplies are purchased on account for $950. The bill is payable within 30 days.

January 15: Wages of $4,230 for the first half of the month are paid in cash.

January 16: A guest mails the business $980 in cash as a deposit for a room to be rented for two weeks. The guest plans to stay at the inn during the last week of January and the first week of February.

January 31: Cash receipts from rentals of rooms for the month amount to $8,300.

January 31: Cash receipts from operation of the restaurant for the month amount to $6,600.

January 31: Each stockholder is paid $200 in cash dividends.

Required

Identify and analyze the necessary adjustments for each of the following:

a. Depreciation of the house

b. Depreciation of the furniture

c. Interest on the promissory note

d. Recognition of the expired portion of the insurance

e. Recognition of a portion of the guest’s deposit

f. Wages earned during the second half of January amount to $5,120 and will be paid on February 3.

g. Cleaning supplies on hand on January 31 amount to $230.

h. A gas and electric bill that is received from the city amounts to $740 and is payable by February 5.

i. Income taxes are to be accrued at a rate of 30% of income before taxes.

To determine

Introduction: The users of financial statements review the financial statements of the company and perform appropriate analysis to take appropriate decisions, whenever required.

To prepare: Identify and analyze adjusting entry.

Explanation of Solution

Adjusting entries

S. No.	Particulars	Debit ($)	Credit ($)
a.	Depreciation expense- house   Dr. Accumulated depreciation-house (To record depreciation expense on house, note 1.)	150	150
b.	Depreciation expense- furniture   Dr. Accumulated depreciation- furniture (To record depreciation expense on house, note 2.)	125	125
c.	Interest expense   Dr. Interest payable (To record interest expense incurred, note 3.)	300	300
d.	Insurance expense   Dr. Prepaid insurance (To record the amount of expired insurance, note 4.)	250	250
e.	Unearned service revenue   Dr. Service revenue (To record the service revenue earned, note 5.)	490	490
f.	Wages expense   Dr. Wages payable (To record the wages accrued for second half of the month.)	5,120	5,120
g.	Cleaning supplies expense   Dr. Cleaning supplies (To record the utilized cleaning supplies, note 6.)	720	720
h.	Gas and electricity expense   Dr. Gas and electricity payable (To record gas and electricity expense incurred.)	740	740
i.	Income tax expense   Dr. Income tax payable (To record the income tax accrued, note 7.)	3,796.5	3,796.5

Note 1:

  $\begin{array}{l}\begin{array}{l}\text{Depreciation expense = }\frac{\left(\text{Cost – Salvage value}\right)}{\text{Useful life}}\hfill \\ \text{Depreciation expense = }\frac{\left(\text{\$50,000 – \$5,000}\right)}{25}\hfill \\ \text{Depreciation expense = }\frac{\text{\$45,000}}{25}\hfill \\ \text{Depreciation expense = \$1,800}\hfill \\ \text{Depreciation expense p}\text{.m}\text{. = }\frac{\text{\$1,800}}{12}\hfill \end{array}\\ \text{Depreciation expense p}\text{.m}\text{. = \$150}\end{array}$

Note 2:

  $\begin{array}{l}\text{Depreciation expense = }\frac{\left(\text{Cost – Salvage value}\right)}{\text{Useful life}}\hfill \\ \text{Depreciation expense = }\frac{\left(\text{\$15,000 – \$0}\right)}{\text{10}}\hfill \\ \text{Depreciation expense = }\frac{\text{\$15,000}}{\text{10}}\hfill \\ \text{Depreciation expense = \$1,500}\hfill \\ \text{Depreciation expense p}\text{.m}\text{. = }\frac{\text{\$1,500}}{12}\hfill \\ \text{Depreciation expense p}\text{.m}\text{. = \$125}\hfill \end{array}$

Note 3:

  $\begin{array}{l}\text{Interest expense = Principal amount}\times \text{Interest rate}\hfill \\ \text{Interest expense = \$30,000}\times \text{12\%}\hfill \\ \text{Interest expense = \$3,600}\hfill \\ \text{Interest expense p}\text{.m}\text{. = }\frac{\text{\$3,600}}{12}\hfill \\ \text{Interest expense p}\text{.m}\text{. = \$300}\hfill \end{array}$

Note 4:

  $\begin{array}{l}\text{Expired insurance = }\frac{\text{Prepaid insurance}}{\text{Tenure}}\hfill \\ \text{Expired insurance p}\text{.m}\text{. = }\frac{\text{\$6,000}}{\text{24}}\hfill \\ \text{Expired insurance p}\text{.m}\text{. = \$250}\hfill \end{array}$

Note 5:

  $\begin{array}{l}\text{Service revenue earned = }\frac{\text{Unearned service revenue}}{\text{No}\text{. of weeks}}\hfill \\ \text{Service revenue earned = }\frac{\text{\$980}}{2}\hfill \\ \text{Service revenue earned = \$490}\hfill \end{array}$

Note 6:

Cleaning supplies expense = Cleaning supplies (Purchased) − Cleaning supplies (ending) Cleaning supplies expense = $950 - $230

Cleaning supplies expense = $720

Note 7:

Particulars	Sub-total ($)	Total ($)
Service revenue	490
Cash receipts from rentals	8,300
Cash receipts from restaurant	6,600
Total revenues earned (A)		24,740
Depreciation expense − house	150
Depreciation expense − furniture	125
Interest expense	300
Insurance expense	250
Cleaning supplies expense	720
Advertising expense	450
Wages expense ($4,230 + $5,120)	9,350
Gas and electricity bill	740
Total expenses incurred (B)		12,085
Net income [C = (A) − (B)]		12,655

  $\begin{array}{l}\text{Income tax expense = Net income}\times \text{30\%}\hfill \\ \text{Income tax expense = \$12,665}\times \text{30\%}\hfill \\ \text{Income tax expense = \$3,796}\text{.5}\hfill \end{array}$