Adjusting Process - Accounting PDF

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Accounting 25th Edition Carl S. Warren, James M. Reeve, Jonathan E. Duchac

Questions and Solutions

The Adjusting Process

CHAPTER 3 THE ADJUSTING PROCESS DISCUSSION QUESTIONS 1.

a.

Under cash-basis accounting, revenues are reported in the period in which cash is received and expenses are reported in the period in which cash is paid.

b.

Under accrual-basis accounting, revenues are reported in the period in which they are earned and expenses are reported in the same period as the revenues to which they relate.

2.

The matching concept is related to the accrual basis of accounting.

3.

Adjusting entries are necessary at the end of an accounting period to bring the ledger up to date.

4.

Adjusting entries bring the ledger up to date as a normal part of the accounting cycle. Correcting entries correct errors in the ledger.

5.

Four different categories of adjusting entries include prepaid expenses (deferred expenses), unearned revenues (deferred revenues), accrued expenses (accrued liabilities), and accrued revenues (accrued assets).

6.

Statement (a): Increases the balance of a revenue account.

7.

Statement (b): Increases the balance of an expense account.

8.

Yes, because every adjusting entry affects expenses or revenues.

9.

a.

The rights acquired represent an asset.

b.

The justification for debiting Rent Expense is that when the ledger is summarized in a trial balance at the end of the month and statements are prepared, the rent will have become an expense. Hence, no adjusting entry will be necessary.

a.

The portion of the cost of a fixed asset deducted from revenue of the period is debited to Depreciation Expense. It is the expired cost for the period. The reduction in the fixed asset account is recorded by a credit to Accumulated Depreciation rather than to the fixed asset account. The use of the contra asset account facilitates the presentation of original cost and accumulated depreciation on the balance sheet.

b.

Depreciation Expense—debit balance; Accumulated Depreciation—credit balance.

c.

No, it is not customary for the balances of the two accounts to be equal in amount.

d.

Depreciation Expense appears on the income statement; Accumulated Depreciation appears on the balance sheet.

10.

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PRACTICE EXERCISES PE 3–1A a. b.

Yes No

c. d.

No Yes

e. f.

Yes Yes

c. d.

Yes No

e. f.

No Yes

PE 3–1B a. b.

No No

PE 3–2A a. b.

Unearned revenue Prepaid expense

c. d.

Accrued revenue Accrued expense

c. d.

Accrued expense Prepaid expense

PE 3–2B a. b.

Unearned revenue Accrued revenue

PE 3–3A Supplies Expense Supplies Supplies used ($1,975 + $4,125 – $1,850).

4,250 4,250

PE 3–3B Insurance Expense Prepaid Insurance Insurance expired ($9,600 + $12,900 – $7,360).

15,140 15,140

PE 3–4A Unearned Fees Fees Earned Fees earned ($78,500 – $33,675).

44,825 44,825

PE 3–4B Unearned Rent Rent Revenue Rent earned [($18,900 ÷ 12 months) × 7 months].

11,025 11,025

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The Adjusting Process

PE 3–5A Accounts Receivable Fees Earned Accrued fees.

12,840 12,840

PE 3–5B Accounts Receivable Fees Earned Accrued fees.

17,555 17,555

PE 3–6A Salaries Expense Salaries Payable Accrued salaries [($16,250 ÷ 5 days) × 3 days].

9,750 9,750

PE 3–6B Salaries Expense Salaries Payable Accrued salaries [($27,600 ÷ 6 days) × 5 days].

23,000 23,000

PE 3–7A Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

9,100 9,100

PE 3–7B Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

7,700 7,700

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The Adjusting Process

PE 3–8A a. b. c.

Revenues were understated by $44,500. Expenses were understated by $13,100 ($5,800 + $7,300). Net income was understated by $31,400 ($44,500 – $13,100).

PE 3–8B a. b. c.

Revenues were understated by $6,600. Expenses were understated by $10,400 ($1,400 + $9,000). Net income was overstated by $3,800 ($10,400 – $6,600).

PE 3–9A a. b.

The totals are unequal. The debit total is higher by $900 ($9,800 – $8,900). The totals are equal, since the adjusting entry was omitted.

PE 3–9B a.

The totals are equal even though the credit should have been to Wages Payable instead of Accounts Payable.

b.

The totals are unequal. The credit total is higher by $27 ($1,152 – $1,125).

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The Adjusting Process

PE 3–10A HEMLOCK COMPANY Income Statements For Years Ended December 31

a.

2014 Amount

b.

2013 Percent

Amount

Percent

Fees earned Operating expenses

$725,000 435,000

100% 60%

$615,000 356,700

100% 58%

Operating income

$290,000

40%

$258,300

42%

An unfavorable trend of increasing operating expenses and decreasing operating income is indicated.

PE 3–10B CORNEA COMPANY Income Statements For Years Ended December 31

a.

2014 Amount

Fees earned Operating expenses Operating income b.

$1,640,000 869,200 $ 770,800

2013 Percent

100% 53% 47%

Amount

Percent

$1,300,000 715,000 $ 585,000

A favorable trend of decreasing operating expenses and increasing operating income is indicated.

100% 55% 45%

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The Adjusting Process

EXERCISES Ex. 3–1 1. 2. 3. 4.

Prepaid expense Accrued revenue Unearned revenue Accrued expense

5. 6. 7. 8.

Unearned revenue Prepaid expense Accrued expense Accrued expense

Ex. 3–2 Account Accounts Receivable .................................. Cash .............................................................. Interest Expense ......................................... Interest Receivable ..................................... Johann Atkins, Capital ............................... Land .............................................................. Office Equipment ........................................ Prepaid Rent ................................................ Supplies ........................................................ Unearned Fees ............................................ Wages Expense ...........................................

Answer Normally requires adjustment (AR). Does not normally require adjustment. Normally requires adjustment (AE). Normally requires adjustment (AR). Does not normally require adjustment. Does not normally require adjustment. Does not normally require adjustment. Normally requires adjustment (PE). Normally requires adjustment (PE). Normally requires adjustment (UR). Normally requires adjustment (AE).

Ex. 3–3 Supplies Expense Supplies Supplies used ($2,389 – $830).

1,559

Ex. 3–4 $5,810 ($1,560 + $4,250).

Ex. 3–5 a.

Insurance expense (or expenses) will be understated. Net income will be overstated.

b.

Prepaid insurance (or assets) will be overstated. Owner’s equity will be overstated.

1,559

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The Adjusting Process

Ex. 3–6 a. Insurance Expense Prepaid Insurance Insurance expired.

16,450

b. Insurance Expense Prepaid Insurance Insurance expired ($21,700 – $5,250).

16,450

16,450

16,450

Ex. 3–7 a. Insurance Expense Prepaid Insurance Insurance expired ($12,000 + $18,000 – $13,600).

16,400

b. Insurance Expense Prepaid Insurance Insurance expired.

16,400

16,400

16,400

Ex. 3–8 Unearned Fees Fees Earned Fees earned ($37,500 – $12,300).

25,200 25,200

Ex. 3–9 a.

Rent revenue (or revenues) will be understated. Net income will be understated.

b.

Unearned rent (liabilities) will be overstated. Owner’s equity at the end of the period will be understated.

Ex. 3–10 a. Accounts Receivable Fees Earned Accrued fees. b.

8,450

No. If the cash basis of accounting is used, revenues are recognized only when the cash is received. Therefore, earned but unbilled revenues would not be recognized in the accounts, and no adjusting entry would be necessary.

8,450

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The Adjusting Process

Ex. 3–11 a. Unearned Fees Fees Earned Unearned fees earned during year.

71,600

b. Accounts Receivable Fees Earned Accrued fees earned.

47,400

71,600

47,400

Ex. 3–12 a.

Fees earned (or revenues) will be understated. Net income will be understated.

b. Accounts (fees) receivable (or assets) will be understated. Owner’s equity will be understated.

Ex. 3–13 a. Salaries Expense Salaries Payable Accrued salaries [($11,750 ÷ 5 days) × 3 days].

7,050

b. Salaries Expense Salaries Payable Accrued salaries [($11,750 ÷ 5 days) × 4 days].

9,400

7,050

9,400

Ex. 3–14 $66,075 ($73,250 – $7,175)

Ex. 3–15 a.

Salary expense (or expenses) will be understated. Net income will be overstated.

b.

Salaries payable (or liabilities) will be understated. Owner’s equity will be overstated.

Ex. 3–16 a.

Salary expense (or expenses) will be overstated. Net income will be understated.

b. The balance sheet will be correct. This is because salaries payable has been satisfied, and the net income errors have offset each other. Thus, owner’s equity is correct.

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The Adjusting Process

Ex. 3–17 a. Taxes Expense Prepaid Taxes Prepaid taxes expired [($28,800 ÷ 12 months) × 9 months]. Taxes Expense Taxes Payable Accrued taxes. b.

21,600 21, 600

49,800 49,800

$71,400 ($21,600 + $49,800)

Ex. 3–18 Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

6,760

Ex. 3–19 a.

$650,000 ($1,375,000 – $725,000)

b.

No. Depreciation is an allocation of the cost of the equipment to the periods benefiting from its use. It does not necessarily relate to value or loss of value.

Ex. 3–20 a.

$7,630 million ($16,259 – $8,629)

b.

No. Depreciation is an allocation method, not a valuation method. That is, depreciation allocates the cost of a fixed asset over its useful life. Depreciation does not attempt to measure market values, which may vary significantly from year to year.

Ex. 3–21 Income: $3,947 million ($2,054 + $1,893)

Ex. 3–22 a.

$560 million

b.

45.1% ($560 ÷ $1,242)

6,760

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The Adjusting Process

Ex. 3–23

1.

Revenue for the year would be………………

2. 3. 4.

Expenses for the year would be…………….. Net income for the year would b e…………... Assets at August 31 would be……………….

5. 6.

Owner’s equity at August 31 would be…….

Liabilities at August 31 would be……………

Error (a) UnderOverstated stated $ 0 $23,250 0 0 0 23,250 0 0 0 23,250 0 23,250

Error (b) OverUnderstated stated $ 0 $ 0 0 4,000 4,000 0 0 0 0 4,000 4,000 0

Ex. 3–24 $132,900 ($113,650 + $23,250 – $4,000)

Ex. 3–25 a.

b.

Depreciation Expense Accumulated Depreciation—Equipment Depreciation on equipment.

13,900

(1)

Depreciation expense would be understated. Net income would be overstated.

(2)

Accumulated depreciation would be understated, and total assets would be overstated. Owner’s equity would be overstated.

13,900

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The Adjusting Process

Ex. 3–26 1. Accounts Receivable Fees Earned Accrued fees earned.

3

2. Supplies Expense Supplies Supplies used.

1

3. Insurance Expense Prepaid Insurance Insurance expired.

6

4. Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

2

5. Wages Expense Wages Payable Accrued wages.

1

3

1

6

2

1

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The Adjusting Process

Ex. 3–27 1.

The accountant debited Accounts Receivable for $5,000 but did not credit Laundry Revenue. This adjusting entry represents accrued laundry revenue.

2.

The accountant debited rather than credited Laundry Supplies for $3,000.

3.

The accountant credited the prepaid insurance account for $3,600, but debited the insurance expense account for only $600.

4.

The accountant credited Laundry Equipment for the depreciation expense of $13,000, instead of crediting the accumulated depreciation account.

5.

The accountant did not debit Wages Expense for $1,000.

The corrected adjusted trial balance is shown below. EVA'S LAUNDRY Adjusted Trial Balance May 31, 2014 Debit Balances

Cash Accounts Receivable Laundry Supplies Prepaid Insurance Laundry Equipment Accumulated Depreciation—Laundry Equipment Accounts Payable Wages Payable Eva Bruns, Capital Eva Bruns, Drawing Laundry Revenue Wages Expense Rent Expense Utilities Expense Depreciation Expense Laundry Supplies Expense Insurance Expense Miscellaneous Expense

Credit Balances

7,500 23,250 750 1,600 190,000 61,000 9,600 1,000 110,300 28,775 187,100 50,200 25,575 18,500 13,000 3,000 3,600 3,250 369,000

369,000

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The Adjusting Process

Ex. 3–28 a.

$420 million increase ($1,907 – $1,487) 28.2% ($420 ÷ $1,487) increase

b.

Year 2: 10.0% ($1,907 ÷ $19,014) Year 1: 7.8% ($1,487 ÷ $19,176)

c.

The net income increased during Year 2 by $420 million from Year 1. Net income as a percent of net sales also increased from 7.8% in Year 1 to 10.0% in Year 2. Both of these results are favorable trends for Nike.

Ex. 3–29 a.

Dell Inc. Amount

Net sales Cost of goods sold Operating expenses Operating income (loss) b.

$61,494 (50,098) (7,963) $ 3,433

100.0% 81.5% 12.9% 5.6%

Hewlett-Packard Company (HP) Amount

Net sales Cost of goods sold Operating expenses Operating income (loss) c.

Percent

$126,033 (96,089) (18,465) $ 11,479

Percent

100.0% 76.2% 14.7% 9.1%

Hewlett-Packard (HP) is more profitable than Dell. Specifically, HP’s cost of goods sold of 76.2% is 5.3% (81.5% – 76.2%) less than Dell’s cost of goods sold. This is partially offset by HP’s higher operating expenses of 14.7% as compared to Dell's operating expenses of 12.9%. The net result is that HP generates an operating income of 9.1% of sales, while Dell generates operating income of 5.6% of sales. Dell must improve its operations if it is to remain competitive with HP.

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PROBLEMS Prob. 3–1A 1.

a.

b.

c.

d.

e.

2.

Supplies Expense Supplies Supplies used ($6,880 – $2,200).

4,680

Unearned Rent Rent Revenue Rent earned ($9,200 ÷ 4 months).

2,300

Wages Expense Wages Payable Accrued wages.

1,850

Accounts Receivable Fees Earned Accrued fees earned. Depreciation Expense Accumulated Depreciation—Office Equipment Depreciation expense.

4,680

2,300

1,850

11,700 11,700

3,500

Adjusting entries are a planned part of the accounting process to update the accounts. Correcting entries are not planned, but arise only when necessary to correct errors.

3,500

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Prob. 3–2A 1.

a.

b.

c.

d.

e.

f.

Accounts Receivable Fees Earned Accrued fees earned.

9,150

Supplies Expense Supplies Supplies used ($3,000 – $675).

2,325

Rent Expense Prepaid Rent Prepaid rent expired.

5,000

Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation.

3,300

Unearned Fees Fees Earned Fees earned ($10,500 – $3,000).

7,500

Wages Expense Wages Payable Accrued wages.

3,100

9,150

2,325

5,000

3,300

7,500

2.

Fees Earned would be understated by $9,150; Wages Expense would be understated by $3,100; and net income would be understated by $6,050 ($9,150 – $3,100).

3.

Accounts Receivable would be understated by $9,150; total assets would be understated by $9,150; Wages Payable would be understated by $3,100; total liabilities would be understated by $3,100; owner’s capital would be understated by $6,050 ($9,150 – $3,100); and total liabilities and owner’s equity would be understated by $9,150 ($3,100 + $6,050).

4.

There is no effect on the “Net increase or decrease in cash” on the statement of cash flows, since adjusting entries do not affect cash.

3,100

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The Adjusting Process

Prob. 3–3A 1.

a.

b.

c.

d.

e.

Accounts Receivable Fees Earned Accrued fees earned.

12,700

Supplies Expense Supplies Supplies used ($21,600 – $4,175).

17,425

12,700

Depreciation Expense Accumulated Depreciation—Equipment Equipment depreciation. Unearned Fees Fees Earned Fees earned. Wages Expense Wages Payable Accrued wages.

17,425

7,400 7,400

14,200 14,200

1,100 1,100

2.

Revenues…………………… Expenses…………………… Net Income…………………

$393,000 301,800 ($126,000 + $96,000 + $69,000 + $10,800) $ 91,200

3.

Revenues…………………… Expenses…………………… Net Income……………………

$419,900 ($393,000 + $12,700 + $14,200) 327,725 ($301,800 + $17,425 + $7,400 + $1,100) $ 92,175

4.

The effect of the adjusting entries on Amy Wolf, Capital is the difference in net income in (2) and (3) of $975 ($92,175 – $91,200), which increases Amy Wolf, Capital.

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