Chapter 5, Problem 5.1COP

Recording Transactions and Adjustments, Reconciling Items, and Preparing Financial Statements

On January 1, Pulse Recording Studio (PRS) had the following account balances.

The following transactions occurred during January.

1. 1. Received $2,500 cash on l/l from customers on account for recording services completed in December.
2. 2. Wrote checks on 1/2 totaling $4,000 for amounts owed on account at the end of December.
3. 3. Purchased and received supplies on account on 1/3, at a total cost of $200.
4. 4. Completed $4,000 of recording sessions on 1/4 that customers had paid for in advance in December.
5. 5. Received $5,000 cash on 1/5 from customers for recording sessions started and completed in January.
6. 6. Wrote a check on 1/6 for $4,000 for an amount owed on account.
7. 7. Converted $1,000 of cash equivalents into cash on 1/7.
8. 8. On 1/15, completed EFTs for $1,500 for employees’ salaries and wages for the first half of January.
9. 9. Received $3,000 cash on 1/31 from customers for recording sessions to start in February.

Required:

1. 1. Prepare journal entries for the January transactions.
2. 2. Enter the January 1 balances into T-accounts, post the journal entries from requirement 1, and calculate January 31 balances. (If you are completing this requirement in Connect, this requirement will be completed for you.)
3. 3. Use the January 31 balance in Cash from requirement 2 and the following information to prepare a bank reconciliation. PRS’s bank reported a January 31 balance of $6,300.
4. 10. The bank deducted $500 for an NSF check from a customer deposited on January 5.
5. 11. The check written January 6 has not cleared the bank, but the January 2 payment has cleared.
6. 12. The cash received and deposited on January 31 was not processed by the bank until February 1.
7. 13. The bank added $5 cash to the account for interest earned in January.
8. 14. The bank deducted $5 for service charges.
9. 4. Prepare journal entries for items (10)–(14) from the bank reconciliation, if applicable, and post them to the T-accounts. If a journal entry is not required for one or more of the reconciling items, indicate “no journal entry required.” (If you are using Connect, journal entries will be automatically posted after you enter them.)
10. 5. Prepare adjusting journal entries on 1/31, using the following information.
11. 15. Depreciation for the month is $200.
12. 16. Salaries and wages totaling $1,500 have not yet been recorded for January 16–31.
13. 17. Prepaid Rent will be fully used up by March 31.
14. 18. Supplies on hand at January 31 were $500.
15. 19. Received $600 invoice for January electricity charged on account to be paid in February but is not yet recorded.
16. 20. Interest on the promissory note of $60 for January has not yet been recorded or paid.
17. 21. Income tax of $1,000 on January income has not yet been recorded or paid.
18. 6. Post the adjusting journal entries from requirement 5 to the T-accounts and prepare an adjusted trial balance. (If you are completing this requirement in Connect, it will be completed for you using your previous answers.)
19. 7. Prepare an income statement for January and a classified balance sheet at January 31. Report PRS’s cash and cash equivalents as a single line on the balance sheet.
20. 8. Calculate the current ratio at January 31 and indicate whether PRS has met its loan covenant that requires a minimum current ratio of 1.2.
21. 9. Calculate the net profit margin and indicate whether PRS has achieved its objective of 10 percent.

To determine

To prepare: Journal entries for the transactions occurred in January in the books of PR Studio

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

Prepare journal entry for the transaction occurred on January 1.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	1	Cash			2,500
			Accounts Receivable			2,500
		(To record cash received for services on account)

Table (1)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Accounts Receivable is an asset account. Since amount to be received has decreased, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for the transaction occurred on January 2.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	2	Accounts Payable			4,000
			Cash			4,000
		(To record payment of on account purchases)

Table (2)

Description:

• Accounts Payable is a liability account. Since the amount to be paid is paid, liability decreased, and a decrease in liability is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for the transaction occurred on January 3.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	3	Supplies			200
			Accounts Payable			200
		(To record purchase of supplies on account)

Table (3)

Description:

• Supplies is an asset account. Since supplies are bought, asset account increased, and an increase in asset is debited.
• Accounts Payable is a liability account. Since the amount to be paid increased, liability increased, and an increase in liability is credited.

Prepare journal entry for the transaction occurred on January 4.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
January	4	Unearned Revenue			4,000
			Service Revenue			4,000
		(To record revenue earned, paid for in advance in December)

Table (4)

Description:

• Unearned Revenue is a liability account. Since the unearned revenue is earned, liability is reduced, and a decrease in liability is debited.
• Service Revenue is a revenue account. Since the unearned revenue has been earned, revenue value increased, and an increase in revenues increases stockholders’ equity. Hence, the account is credited.

Prepare journal entry for the transaction occurred on January 5.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	5	Cash			5,000
			Service Revenue			5,000
		(To record revenue received for services performed)

Table (5)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Service Revenue is a revenue account. Since revenues increase equity, equity value is increased. An increase in equity is credited.

Prepare journal entry for the transaction occurred on January 6.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	6	Accounts Payable			4,000
			Cash			4,000
		(To record payment of on account purchases)

Table (6)

Description:

• Accounts Payable is a liability account. Since the amount to be paid is paid, liability decreased, and a decrease in liability is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for the transaction occurred on January 7.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	7	Cash			1,000
			Cash Equivalents			1,000
		(To record conversion of cash equivalents into cash)

Table (7)

Description:

• Cash is an asset account. Since cash equivalents are converted to cash, asset account increased, and an increase in asset is debited.
• Cash Equivalents is an asset account. Since cash equivalent re converted into cash, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for the transaction occurred on January 15.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	15	Salaries and Wages Expense			1,500
			Cash			1,500
		(To record payment of wages and salaries expense)

Table (8)

Description:

• Salaries and Wages Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Cash is an asset account. Since cash is paid, asset account decreased, and a decrease in asset is credited.

Prepare journal entry for the transaction occurred on January 31.

Date		Account Titles and Explanations		Post. Ref.	Debit ($)	Credit ($)
January	31	Cash			3,000
			Unearned Revenue			3,000
		(To record revenue received for future services to be performed)

Table (9)

Description:

• Cash is an asset account. Since cash is received, asset account increased, and an increase in asset is debited.
• Unearned Revenue is a liability account. Since cash received for services to be performed, liability is increased. An increase in liability is credited.

To determine

To open: The T-accounts with balances as on January 1, post the entries recorded in Part (1), and compute the balances as on January 31

Explanation of Solution

T-account: The condensed form of a ledger is referred to as T-account. The left-hand side of this account is known as debit, and the right hand side is known as credit.

Open the T-accounts with balances as on January 1, post the entries recorded in Part (1), and compute the balances as on January 31.

Cash
January1	3,800	4,000	January 2
January 1	2,500	4,000	January 6
January 5	5,000	1,500	January 15
January 1	1,000
January 1	3,000
Total	15,300	9,500	Total
Balance	$5,800

Table (10)

Cash Equivalents
January 1	1,500	1,000	January 7
Total	1,500	1,000	Total
Balance	$500

Table (11)

Accounts Receivable
January 1	7,000	2,500	January 1
Total	7,000	2,500	Total
Balance	$4,500

Table (12)

Supplies
January 1	500
January 3	200
Balance	$700

Table (13)

Prepaid Rent
January 1	3,000
Balance	$3,000

Table (14)

Equipment
January 1	30,000
Balance	$30,000

Table (15)

Accumulated Depreciation–Equipment
		6,000	January 1
		$6,000	Balance

Table (16)

Accounts Payable
January 1	4,000	8,500	January 1
January 6	4,000	200	January 3
Total	8,000	8,700	Total
		$700	Balance

Table (17)

Unearned Revenue
January 1	4,000	4,000	January 1
		3,000	January 31
Total	4,000	7,000	Total
		$3,000	Balance

Table (18)

Notes Payable
		12,000	January 1
		$12,000	Balance

Table (19)

Common Stock
		10,000	January 1
		$10,000	Balance

Table (20)

Retained Earnings
		10,000	January 1
		$10,000	Balance

Table (21)

Service Revenue
		0	January 1
		4,000	January 4
		5,000	January 5
		$9,000	Balance

Table (22)

Salaries and Wages Expense
January 1	0
January 15	1,500
Balance	$1,500

Table (23)

To determine

To prepare: Bank reconciliation of PR Studio, as at January 31

Explanation of Solution

Bank reconciliation: Bank statement is prepared by bank. The company maintains its own records from its perspective. This is why the cash balance per bank and cash balance per books seldom agree. Bank reconciliation is the statement prepared by company to remove the differences and disagreement between cash balance per bank and cash balance per books.

Prepare bank reconciliation of PR Studio, as at January 31.

PR Studio
Bank Reconciliation
January 31
Updates to Bank Statement		Updates to Company’s Books
Ending cash balance per bank statement	$6,300	Ending cash balance per books		$5,800
Additions:		Additions:
Deposits in transit	3,000	Interest received		5
	9,300			5,805
Deductions:		Deductions:
Outstanding checks	4,000	NSF check	500
Up-to-date ending cash balance	$5,300	Bank service charge	5	505
		Up-to-date ending cash balance		$5,300

Table (24)

Description:

• The deposits which are not recorded by the bank are referred to as deposits in transit. Since the deposits in transit are not reflected on the bank statement, the company should add deposits in transit to cash balance per bank, while preparation of bank reconciliation statement.
• Outstanding checks are the checks that are issued by the company, but not yet paid by the bank. When the check is issued for payment, the company deducts the cash balance immediately. But the bank deducts only when the cash is paid for the issued check. So, company deducts the cash balance per bank to remove the differences.
• Interest received is credited by bank to the bank account of which the company is not aware of. So, while preparing bank reconciliation statement, company should add the amount to the cash balance per books.
• While bank reconciliation, the NSF check should be deducted from the cash balance per book. This is because the bank could not collect funds from the customer’s bank due to lack of funds. But being recorded as Accounts Receivable previously, the balance should be deducted from books, to increase the Accounts Receivable account.
• Banks deduct the service charge for the services rendered like lock box rental, or printed checks. But the company is not aware of such deductions. So, company deducts the cash balance per books while bank reconciliation preparation.

To determine

To prepare: Adjusting journal entries for items (10) to (14) that arise due to bank reconciliation, and post the entries into T-accounts

Explanation of Solution

Journal entry: Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

Debit and credit rules:

• Debit an increase in asset account, increase in expense account, decrease in liability account, and decrease in stockholders’ equity accounts.
• Credit decrease in asset account, increase in revenue account, increase in liability account, and increase in stockholders’ equity accounts.

(10)

Prepare journal entry to record NSF check.

Date		Account Titles and Explanation		Ref.	Debit ($)	Credit ($)
January	31	Accounts Receivable			500
			Cash			500
		(To record NSF check)

Table (25)

Description:

• Accounts Receivable is an asset account. The bank has not collected the amount from the customer due to insufficient funds, which was earlier recorded as a receipt. As the collection could not be made, amount to be received increased. Therefore, increase in asset would be debited.
• Cash is an asset account. The amount is decreased because bank could not collect amount due to insufficient funds in customer’s account, and a decrease in asset is credited.

(11)

Prepare journal entry for the checks written but not cleared by bank.

These are the outstanding checks, which are recorded by the company. So, company does not record it again, but this is an adjustment for bank balance. Hence, no journal entry is required.

(12)

Prepare journal entry for the deposits recorded by company.

These are the checks deposited by company but not recorded by bank, which are recorded by the company. So, company does not record it again, but this is an adjustment for bank balance. Hence, no journal entry is required.

(13)

Prepare journal entry to record interest received.

Date		Account Titles and Explanation		Ref.	Debit ($)	Credit ($)
January	31	Cash			5
			Interest Revenue			5
		(To record interest earned)

Table (26)

Description:

• Cash is an asset account. The amount is increased because credited the interest earned on checking account, and an increase in asset is debited.
• Interest Revenue is a revenue account. Revenuesincrease Equity account and an increase in Equity is credited.

(14)

Prepare journal entry to record bank service charge.

Date		Account Titles and Explanation		Ref.	Debit ($)	Credit ($)
January	31	Office Expense			5
			Cash			5
		(To record bank service charge)

Table (27)

Description:

• Office Expenses is an expense account and the amount is increased because bank has charged service charges. Expenses decrease Equity account and decrease in Equity is debited.
• Cash is an asset account. The amount is decreased because bank service charge is paid, and a decrease in asset is credited.

Prepare T-accounts.

Cash
Balance	$5,800
January 31	5	500	January 31
		5	January 31
Total	5,805	505	Total
Balance	$5,300

Table (28)

Accounts Receivable
Balance	$4,500
January 31	500
Balance	$5,000

Table (29)

Interest Revenue
		0	January 1
		5	January 31
		$5	Balance

Table (30)

Office Expense
January 1	0
January 31	5
Balance	$5

Table (31)

To determine

To journalize: The adjusting entries for the items (19) to (21) as on January 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.

15.

Prepare adjusting entry for the depreciation expense as on January 31.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
January	31	Depreciation Expense			200
			Accumulated Depreciation–Equipment			200
		(To record depreciation expense)

Table (32)

Description:

• Depreciation Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Accumulated Depreciation–Equipment is a contra-asset account, and contra-asset accounts would have a normal credit balance, hence, the account is credited.

16.

Prepare adjusting entry for the wages expense as on January 31.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
January	31	Salaries and Wages Expense			1,500
			Salaries and Wages Payable			1,500
		(To record accrued expenses)

Table (33)

Description:

• Salaries and Wages Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Salaries and Wages Payable is a liability account. Since amount of payables has increased, liability decreased, and an increase in liability is credited.

17.

Prepare adjusting entry for the prepaid rent as on January 31.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
January	31	Rent Expense			1,000
			Prepaid Rent			1,000
		(To record part of prepaid rent expired)

Table (34)

Description:

• Rent Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Prepaid Rent is an asset account. Since amount of rent is expired, asset account decreased, and a decrease in asset is credited.

18.

Prepare adjusting entry for the supplies as on January 31.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
January	31	Supplies Expense			200
			Supplies			100
		(To record part of supplies consumed)

Table (35)

Description:

• Supplies Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Supplies is an asset account. Since amount of supplies is used, asset account decreased, and a decrease in asset is credited.

19.

Prepare adjusting entry for the utilities expense as on January 31.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
January	31	Utilities Expense			600
			Accounts Payable			600
		(To record accrued expenses)

Table (36)

Description:

• Utilities Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Accounts Payable is a liability account. Since amount of payables has increased, liability decreased, and an increase in liability is credited.

20.

Prepare adjusting entry for the interest expense as on January 31.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
January	31	Interest Expense			600
			Interest Payable			600
		(To record accrued expenses)

Table (37)

Description:

• Interest Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Interest Payable is a liability account. Since amount of payables has increased, liability decreased, and an increase in liability is credited.

21.

Prepare adjusting entry for the utilities expense as on January 31.

Date		Account Titles and Explanation		Post Ref.	Debit ($)	Credit ($)
January	31	Income Tax Expense			600
			Income Tax Payable			600
		(To record accrued expenses)

Table (38)

Description:

• Income Tax Expense is an expense account. Since expenses decrease equity, equity value is decreased, and a decrease in equity is debited.
• Income Tax Payable is a liability account. Since amount of payables has increased, liability decreased, and an increase in liability is credited.

To determine

To journalize: Post the adjusted entries into T-accounts, and prepare adjusted trial balance for PR Studio as on January 31

Explanation of Solution

Post the adjusting entries into T-accounts.

Supplies
Balance	700
		200	January 31
Total	700	200	Total
Balance	$500

Table (39)

Prepaid Rent
Balance	3,000	1,000	January 31
Balance	$2,000

Table (40)

Accumulated Depreciation–Equipment
		6,000	Balance
		200	January 31
		$6,200	Balance

Table (41)

Interest Payable
		60	January 31
		$60	Balance

Table (42)

Income Tax Payable
		1,000	January 31
		$1,000	Balance

Table (43)

Salaries and Wages Payable
		1,500	January 31
		$1,500	Balance

Table (44)

Accounts Payable
		700	Balance
		600	January 31
		$1,300	Balance

Table (45)

Depreciation Expense
January 1	0
January 31	200
Balance	$200

Table (46)

Rent Expense
January 1	0
January 31	1,000
Balance	$1,000

Table (47)

Supplies Expense
January 1	0
January 31	200
Balance	$200

Table (48)

Utilities Expense
January 1	0
January 31	600
Balance	$600

Table (49)

Interest Expense
January 1	0
January 31	60
Balance	$60

Table (50)

Income Tax Expense
January 1	0
January 31	1,000
Balance	$1,000

Table (51)

Salaries and Wages Expense
January 1	1,500
January 31	1,500
Balance	$3,000

Table (52)

Adjusted trial balance: It is that statement which shows all the asset, liability, and equity account balances at the year-end, after recording of adjusting entries.

Prepare adjusted trial balance of PR Studio as on January 31.

PR Studio
Adjusted Trial Balance
January 31
Particulars	Debit $	Credit $
Cash	$5,300
Cash Equivalents	500
Accounts Receivable	5,000
Prepaid Rent	2,000
Supplies	500
Equipment	30,000
Accumulated Depreciation - Equipment		6,200
Accounts Payable		1,300
Interest Payable		60
Income Tax Payable		1,000
Salaries and Wages Payable		1,500
Unearned Revenue		3,000
Notes Payable (Long-term)		12,000
Common Stock		10,000
Retained Earnings		5,300
Service Revenue		9,000
Interest Revenue		5
Salaries and Wages Expense	3,000
Rent Expense	1,000
Income Tax Expense	1,000
Utilities Expense	600
Depreciation Expense	200
Supplies Expense	200
Interest Expense	60
Office Expense	5
Total	$49,365	$49,365

Table (53)

To determine

To prepare: Income statement of PR Studio for the month ended January 31, and classified balance sheet of PR Studio as on January 31

Explanation of Solution

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Prepare income statement for PR Studio for the month ended January 31.

PR Studio
Income Statement
For the Month Ended January 31
Revenue
Service revenue	$9,000
Interest revenue	5
Total revenue		$9,005
Expenses
Salaries and wages expense	$3,000
Rent expense	1,000
Income tax expense	1,000
Utilities expense	600
Depreciation expense	200
Supplies expense	200
Interest expense	60
Office expense	5
Total expenses		6,065
Net income		$2,940

Table (54)

Classified balance sheet: The main elements of balance sheet assets, liabilities, and stockholders’ equity are categorized or classified further into sections in a classified balance sheet. Assets are further classified as current assets, long-term investments, property, plant, and equipment (PPE), and intangible assets. Liabilities are classified into two sections current and long-term. Stockholders’ equity comprises of common stock and retained earnings. Thus, the classified balance sheet includes all the elements under different sections.

Prepare classified balance sheet for PR Studio, as at January 31.

PR Studio
Balance Sheet
January 31
Assets
Current assets
Cash and cash equivalents	$5,800
Accounts receivable	5,000
Supplies	500
Prepaid rent	2,000
Total current assets		$13,300
Property, plant, and equipment
Equipment	30,000
Less: Accumulated depreciation	6,200	23,800
Total assets		$37,100
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$1,300
Interest payable	60
Income tax payable	1,000
Salaries and wages payable	1,500
Unearned revenue	3,000
Total current liabilities		$6,860
Long-term liabilities
Notes payable		12,000
Total liabilities		18,860
Stockholders’ equity
Common stock	10,000
Retained earnings	8,240
Total stockholders’ equity		18,240
Total liabilities and stockholders’ equity		$37,100

Table (55)

Working Notes:

Compute retained earnings for the month ended January 31.

Particulars	Amount ($)
Retained earnings, January 1	$5,300
Add: Net income	2,940
	8,240
Less: Dividends	0
Retained earnings, January 31	$8,240

Table (56)

Note: Refer to Table (54) for net income value.

To determine

The current ratio of PR Studio for the month ended January 31

Explanation of Solution

Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Formula of current ratio:

$\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}$

Compute current ratio of PR Studio for the month ended January 31, if current assets are $13,300 and current liabilities are $6,860.

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}\\ \text{=}\frac{\text{\$13,300}}{\text{\$6,860}}\\ =1.94:1\end{array}$

Conclusion

Yes, PR Studio has met its loan covenant because its current ratio, 1.94 is more than the minimum current ratio of 1.2.

To determine

The net profit margin for the month ended January 31

Explanation of Solution

Net profit margin: This ratio gauges the operating profitability by quantifying the amount of income earned from business operations from the sales generated.

Formula of net profit margin:

$\text{Net profit margin}=\frac{\text{Net income}}{\text{Total revenue}}$

Determine the net profit margin for PR Studio for the month ended January 31, if net income is $2,940 and total revenue is $9,005.

$\begin{array}{c}\text{Net profit margin}=\frac{\text{Net income}}{\text{Total revenue}}\\ =\frac{\text{\$2,940}}{\$9,005}\\ \text{= 0}\text{.3265 or 32}\text{.65\%}\end{array}$

Note: Refer to Table (54) for both values.