Introduction to Financial Accounting - Chapter 3 - Adjusting Entries (2019A) - PDF

with Open Texts Introduction to Financial Accounting by Henry Dauderis & David Annand Edited by Athabasca University VERSION 2019– REVISION A ADAPTABLE | ACCESSIBLE | AFFOR...

with Open Texts Introduction to Financial Accounting by Henry Dauderis & David Annand Edited by Athabasca University VERSION 2019– REVISION A ADAPTABLE | ACCESSIBLE | AFFORDABLE *Creative Commons License (CC BY-NC-SA)  a d v a n c i n g l e a r n i n g Introduction to Financial Accounting by Henry Dauderis & David Annand Edited by Athabasca University Version 2019 — Revision A BE A CHAMPION OF OER! Contribute suggestions for improvements, new content, or errata: A new topic A new example An interesting new question Any other suggestions to improve the material Contact Lyryx at [email protected] with your ideas. Lyryx Learning Team Bruce Bauslaugh Martha Laflamme Peter Chow Jennifer MacKenzie Nathan Friess Tamsyn Murnaghan Stephanie Keyowski Bogdan Sava Claude Laflamme Ryan Yee LICENSE Creative Commons License (CC BY-NC-SA): This text, including the art and illustrations, are available under the Creative Commons license (CC BY-NC-SA), allowing anyone to reuse, revise, remix and redistribute the text. To view a copy of this license, visit http://creativecommons.org/licenses/by-nc-sa/3.0/ Chapter 3 Financial Accoun ng and Adjus ng Entries Chapters 1 and 2 described the recording and repor ng of economic transac ons in detail. How- ever, the account balances used to prepare the financial statements in these previous chapters did not necessarily reflect correct amounts. Chapter 3 introduces the concept of adjus ng entries and how these sa sfy the matching principle, ensuring revenues and expenses are reported in the correct accoun ng period. The prepara on of an adjusted trial balance is discussed, as well as its use in comple ng financial statements. At the end of the accoun ng period, a er financial statements have been prepared, it is necessary to close temporary accounts to retained earnings. This process is introduced in this chapter, as is the prepara on of a post-closing trial balance. The accoun ng cycle, the steps performed each accoun ng period that result in financial statements, is also reviewed. Chapter 3 Learning Objec ves LO1 – Explain how the meliness, matching, and recogni on GAAP require the recording of adjus ng entries. LO2 – Explain the use of and prepare the adjus ng entries required for prepaid expenses, deprecia on, unearned revenues, accrued revenues, and accrued expenses. LO3 – Prepare an adjusted trial balance and explain its use. LO4 – Use an adjusted trial balance to prepare financial statements. LO5 – Iden fy and explain the steps in the accoun ng cycle. LO6 – Explain the use of and prepare closing entries and a post-closing trial balance. Concept Self-Check Use the following as a self-check while working through Chapter 3. 1. What is the GAAP principle of meliness? 2. What is the GAAP principle of matching? 3. What is the GAAP principle of revenue recogni on? 4. What are adjus ng entries and when are they journalized? 97  98 Financial Accoun ng and Adjus ng Entries 5. What are the five types of adjustments? 6. Why is an adjusted trial balance prepared? 7. How is the unadjusted trial balance different from the adjusted trial balance? 8. What are the four closing entries and why are they journalized? 9. Why is the Dividends account not closed to the income summary? 10. When is a post-closing trial balance prepared? 11. How is a post-closing trial balance different from an adjusted trial balance? NOTE: The purpose of these ques ons is to prepare you for the concepts introduced in the chap- ter. Your goal should be to answer each of these ques ons as you read through the chapter. If, when you complete the chapter, you are unable to answer one or more the Concept Self-Check ques ons, go back through the content to find the answer(s). Solu ons are not provided to these ques ons. 3.1 The Opera ng Cycle Financial transac ons occur con nuously during an accoun ng period as LO1 – Explain part of a sequence of opera ng ac vi es. For Big Dog Carworks Corp., this how the meli- sequence of opera ng ac vi es takes the following form: ness, matching, and recogni on 1. Opera ons begin with some cash on hand. GAAP require 2. Cash is used to purchase supplies and to pay expenses. the recording of adjus ng 3. Revenue is earned as repair services are completed for customers. entries. 4. Cash is collected from customers. This cash-to-cash sequence of transac ons is commonly referred to as an opera ng cycle and is illustrated in Figure 3.1.  3.1. The Opera ng Cycle 99 Cash payment to supplier is made. Repair services are performed. Expenses are paid. Repair supplies are purchased. Accounts receivable result. Cash is Cash is collected on hand. from customer. One Opera ng Cycle Time Figure 3.1: One Opera ng Cycle Depending on the type of business, an opera ng cycle can vary in dura on from short, such as one week (e.g., a grocery store) to much longer, such as one year (e.g., a car dealership). Therefore, an annual accoun ng period could involve mul ple opera ng cycles as shown in Figure 3.2. One Accoun ng Period Jan.1, Dec. 31, Time 2015 One 2015 Opera ng Cycle Figure 3.2: Opera ng Cycles Within an Annual Accoun ng Period No ce that not all of the opera ng cycles in Figure 3.2 are completed within the accoun ng pe- riod. Since financial statements are prepared at specific me intervals to meet the GAAP require- ment of meliness, it is necessary to consider how to record and report transac ons related to the accoun ng period’s incomplete opera ng cycles. Two GAAP requirements — recogni on and matching — provide guidance in this area, and are the topic of the next sec ons. Recogni on Principle in More Detail GAAP provide guidance about when an economic ac vity should be recognized in financial state- ments. An economic ac vity is recognized when it meets two criteria:  100 Financial Accoun ng and Adjus ng Entries 1. it is probable that any future economic benefit associated with the item will flow to the business; and 2. it has a value that can be measured with reliability. Revenue Recogni on Illustrated Revenue recogni on is the process of recording revenue in the accoun ng period in which it was earned; this is not necessarily when cash is received. Most corpora ons assume that revenue has been earned at an objec vely-determined point in the accoun ng cycle. For instance, it is o en convenient to recognize revenue at the point when a sales invoice has been sent to a customer and the related goods have been received or services performed. This point can occur before receipt of cash from a customer, crea ng an asset called Accounts Receivable and resul ng in the following entry: General Journal Date Account/Explana on PR Debit Credit Accounts Receivable................... XX Revenue........................... XX To record revenue earned on account. When cash payment is later received, the asset Accounts Receivable is exchanged for the asset Cash and the following entry is made: General Journal Date Account/Explana on PR Debit Credit Cash.................................. XX Accounts Receivable................ XX To record cash received from credit cus- tomer. Revenue is recognized in the first entry (the credit to revenue), prior to the receipt of cash. The second entry has no effect on revenue. When cash is received at the same me that revenue is recognized, the following entry is made: General Journal Date Account/Explana on PR Debit Credit Cash.................................. XX Revenue........................... XX To record cash received from customer. When a cash deposit or advance payment is obtained before revenue is earned, a liability called Unearned Revenue is recorded as follows:  3.1. The Opera ng Cycle 101 General Journal Date Account/Explana on PR Debit Credit Cash.................................. XX Unearned Revenue................. XX To record cash received from customer for work to be done in the future. Revenue is not recognized un l the services have been performed. At that me, the following entry is made: General Journal Date Account/Explana on PR Debit Credit Unearned Revenue..................... XX Revenue........................... XX To record the earned por on of Unearned Revenue. The preceding entry reduces the unearned revenue account by the amount of revenue earned. The matching of revenue to a par cular me period, regardless of when cash is received, is an example of accrual accoun ng. Accrual accoun ng is the process of recognizing revenues when earned and expenses when incurred regardless of when cash is exchanged; it forms the basis of GAAP. Recogni on of expenses is discussed in the next sec on. Expense Recogni on Illustrated In a business, costs are incurred con nuously. To review, a cost is recorded as an asset if it will be incurred in producing revenue in future accoun ng periods. A cost is recorded as an expense if it will be used or consumed during the current period to earn revenue. This dis nc on between types of cost outlays is illustrated in Figure 3.3. COST OUTLAYS Recorded as ASSETS Recorded as EXPENSES When costs are incurred to When costs are incurred to produce revenue in future earn revenue in the present accoun ng periods, for ex- accoun ng period, for example: ample: prepaid rent, prepaid rent expense, insurance expense, insurance, and unused supplies. and office supplies expense. Figure 3.3: The Interrela onship Between Assets and Expense  102 Financial Accoun ng and Adjus ng Entries In the previous sec on regarding revenue recogni on, journal entries illustrated three scenarios where revenue was recognized before, at the same me as, and a er cash was received. Similarly, expenses can be incurred before, at the same me as, or a er cash is paid out. An example of when expenses are incurred before cash is paid occurs when the u li es expense for January is not paid un l February. In this case, an account payable is created in January as follows: General Journal Date Account/Explana on PR Debit Credit U li es Expense....................... XX Accounts Payable (or U li es Payable) XX To record January u li es expense to be paid in February. The u li es expense is reported in the January income statement. When the January u li es are paid in February, the following is recorded: General Journal Date Account/Explana on PR Debit Credit Accounts Payable (or U li es Payable)... XX Cash............................... XX To record payment in February of u li es used in January. The preceding entry has no effect on expenses reported on the February income statement. Expenses can also be recorded at the same me that cash is paid. For example, if salaries for January are paid on January 31, the entry on January 31 is: General Journal Date Account/Explana on PR Debit Credit Salaries Expense....................... XX Cash............................... XX To record payment of January salaries. As a result of this entry, salaries expense is reported on the January income statement when cash is paid. Finally, a cash payment can be made before the expense is incurred, such as insurance paid in advance. A prepayment of insurance creates an asset Prepaid Insurance and is recorded as: General Journal Date Account/Explana on PR Debit Credit Prepaid Insurance...................... XX Cash............................... XX To record payment of insurance in ad- vance.  3.1. The Opera ng Cycle 103 As the prepaid insurance is used, it is appropriate to report an expense on the income statement by recording the following entry: General Journal Date Account/Explana on PR Debit Credit Insurance Expense..................... XX Prepaid Insurance................... XX To record the use of Prepaid Insurance. The preceding examples illustrate how to match expenses to the appropriate accoun ng period. The matching principle requires that expenses be reported in the same period as the revenues they helped generate. That is, expenses are reported on the income statement: a) when related revenue is recognized, or b) during the appropriate me period, regardless of when cash is paid. To ensure the recogni on and matching of revenues and expenses to the correct accoun ng pe- riod, account balances must be reviewed and adjusted prior to the prepara on of financial state- ments. This is the topic of the next sec on.  104 Financial Accoun ng and Adjus ng Entries 3.2 Adjus ng Entries At the end of an accoun ng period, before financial statements can be LO2 – Explain prepared, the accounts must be reviewed for poten al adjustments. This the use of and review is done by using the unadjusted trial balance. The unadjusted trial prepare the balance is a trial balance where the accounts have not yet been adjusted. adjus ng entries The trial balance of Big Dog Carworks Corp. at January 31 was prepared in required for pre- Chapter 2 and appears in Figure 3.4 below. It is an unadjusted trial balance paid expenses, because the accounts have not yet been updated for adjustments. We deprecia on, will use this trial balance to illustrate how adjustments are iden fied and unearned rev- recorded. enues, accrued revenues, and ac- Big Dog Carworks Corp. Unadjusted Trial Balance crued expenses. At January 31, 2015 Acct. Account Debit Credit 101 Cash $3,700 110 Accounts receivable 2,000 161 Prepaid insurance 2,400 183 Equipment 3,000 184 Truck 8,000 201 Bank loan $6,000 210 Accounts payable 700 247 Unearned revenue 400 320 Share capital 10,000 330 Dividends 200 450 Repair revenue 10,000 654 Rent expense 1,600 656 Salaries expense 3,500 668 Supplies expense 2,000 670 Truck opera on expense 700 $27,100 $27,100 Figure 3.4: Unadjusted Trial Balance of Big Dog Carworks Corp. at January 31, 2015 Adjustments are recorded with adjus ng entries. The purpose of adjus ng entries is to ensure both the balance sheet and the income statement faithfully represent the account balances for the accoun ng period. Adjus ng entries help sa sfy the matching principle. There are five types of adjus ng entries as shown in Figure 3.5, each of which will be discussed in the following sec ons.  3.2. Adjus ng Entries 105 Adjust Adjust Adjust Adjust for Adjust for plant and prepaid unearned accrued accrued equipment assets liabili es revenues1 expenses2 assets 1. An accrued revenue is a revenue that has been earned but has not been collected or recorded. 2. An accrued expense is an expense that has been incurred but has not yet been paid or recorded. Figure 3.5: Five Types of Adjus ng Entries Adjus ng Prepaid Asset Accounts An asset or liability account requiring adjustment at the end of an accoun ng period is referred to as a mixed account because it includes both a balance sheet por on and an income statement por on. The income statement por on must be removed from the account by an adjus ng entry. Refer to Figure 3.4 which shows an unadjusted balance in prepaid insurance of $2,400. Recall from Chapter 2 that Big Dog paid for a 12-month insurance policy that went into effect on January 1 (transac on 5). The unadjusted trial balance shows the The balance resulted when following balance in the journal entry below was the Prepaid Insurance recorded: account: Prepaid Insurance 2,400 Prepaid Insurance 2,400 Cash 2,400 At January 31, one month or $200 of the policy has expired (been used up) calculated as $2,400/12 months = $200. The adjus ng entry on January 31 to transfer $200 out of prepaid insurance and into insurance expense is: General Journal Date Account/Explana on PR Debit Credit Jan 31 Insurance Expense..................... 200 Prepaid Insurance................... 200 To adjust for the use of one month of Pre- paid Insurance. As shown below, the balance remaining in the Prepaid Insurance account is $2,200 a er the ad- jus ng entry is posted. The $2,200 balance represents the unexpired asset that will benefit future  106 Financial Accoun ng and Adjus ng Entries periods, namely, the 11 months from February to December, 2015. The $200 transferred out of prepaid insurance is posted as a debit to the Insurance Expense account to show how much insurance has been used during January. Insurance Expense Prepaid Insurance 2,400 200 200 Bal. 2,200 An expense account, An asset account, Prepaid Insurance, Insurance Expense, is decreased by the $200 of insurance is increased by the coverage that was used during January. amount used. If the adjustment was not recorded, assets on the balance sheet would be overstated by $200 and expenses would be understated by the same amount on the income statement. An explora on is available on the Lyryx site. Log into your Lyryx course to run Prepaid Expenses. Adjus ng Unearned Liability Accounts On January 15, Big Dog received a $400 cash payment in advance of services being performed: $300 for January and $100 for February. The unadjusted trial balance shows the The receipt of the $400 advance following in the Un- payment was recorded as follows: earned Repair Rev- enue account: Unearned Repair Revenue 400 Cash 400 Unearned Repair Rev. 400 This advance payment was originally recorded as unearned, since the cash was received before repair services were performed. At January 31, $300 of the $400 unearned amount has been earned. Therefore, $300 must be transferred from unearned repair revenue into repair revenue. The adjus ng entry at January 31 is: General Journal Date Account/Explana on PR Debit Credit Jan 31 Unearned Repair Revenue.............. 300 Repair Revenue..................... 300 To adjust for repair revenue earned.  3.2. Adjus ng Entries 107 A er pos ng the adjustment, the $100 remaining balance in unearned repair revenue ($400 – $300) represents the amount at the end of January that will be earned in February. Unearned Repair Revenue Repair Revenue 400 10,000 300 300 Bal. 100 Bal. 10,300 A liability account, A revenue account, Unearned Repair Rev- Repair Revenue, is enue, is decreased by increased by the $300 the $300 adjustment. adjustment. If the adjustment was not recorded, unearned repair revenue would be overstated (too high) by $300 causing liabili es on the balance sheet to be overstated. Addi onally, revenue would be understated (too low) by $300 on the income statement if the adjustment was not recorded. An explora on is available on the Lyryx site. Log into your Lyryx course to run Unearned Revenues. Adjus ng Plant and Equipment Accounts Plant and equipment assets, also known as long-lived assets, are expected to help generate rev- enues over the current and future accoun ng periods because they are used to produce goods, supply services, or used for administra ve purposes. The truck and equipment purchased by Big Dog Carworks Corp. in January are examples of plant and equipment assets that provide economic benefits for more than one accoun ng period. Because plant and equipment assets are useful for more than one accoun ng period, their cost must be spread over the me they are used. This is done to sa sfy the matching principle. For example, the $100,000 cost of a machine expected to be used over five years is not expensed en rely in the year of purchase because this would cause expenses to be overstated in Year 1 and understated in Years 2, 3, 4, and 5. Therefore, the $100,000 cost must be spread over the asset’s five-year life. The process of alloca ng the cost of a plant and equipment asset over the period of me it is expected to be used is called deprecia on. The amount of deprecia on is calculated using the actual cost and an es mate of the asset’s useful life and residual value. The useful life of a plant and equipment asset is an es mate of how long it will actually be used by the business regardless of how long the asset is expected to last. For example, a car might have a manufacturer’s suggested life of 10 years but a business may have a policy of keeping cars for only 2 years. The useful life for deprecia on purposes would therefore be 2 years and not 10 years. The residual value is an es mate of what the plant and equipment asset will be sold for when it is no longer used by a business. Residual value can be zero. There are different formulas for calcula ng deprecia on. We will use the straight-line method of deprecia on:  108 Financial Accoun ng and Adjus ng Entries Cost − Es mated Residual Value Es mated Useful Life The cost less es mated residual value is the total depreciable cost of the asset. The straight-line method allocates the depreciable cost equally over the asset’s es mated useful life. When record- ing deprecia on expense, our ini al ins nct is to debit deprecia on expense and credit the Plant and Equipment asset account in the same way prepaids were adjusted with a debit to an expense and a credit to the Prepaid asset account. However, credi ng the Plant and Equipment asset ac- count is incorrect. Instead, a contra account called accumulated deprecia on must be credited. A contra account is an account that is related to another account and typically has an opposite nor- mal balance that is subtracted from the balance of its related account on the financial statements. Accumulated deprecia on records the amount of the asset’s cost that has been expensed since it was put into use. Accumulated deprecia on has a normal credit balance that is subtracted from a Plant and Equipment asset account on the balance sheet. Ini ally, the concept of credi ng Accumulated Deprecia on may be confusing because of how we learned to adjust prepaids (debit an expense and credit the prepaid). Remember that prepaids actually get used up and disappear over me. The Plant and Equipment asset account is not cred- ited because, unlike a prepaid, a truck or building does not get used up and disappear. The goal in recording deprecia on is to match the cost of the asset to the revenues it helped generate. For example, a $50,000 truck that is expected to be used by a business for 4 years will have its cost spread over 4 years. A er 4 years, the asset will likely be sold (journal entries related to the sale of plant and equipment assets are discussed in Chapter 8). The adjus ng journal entry to record deprecia on is: General Journal Date Account/Explana on PR Debit Credit Deprecia on Expense.................. XX Accumulated Deprecia on........... XX To adjust for deprecia on. Subtrac ng the accumulated deprecia on account balance from the Plant and Equipment asset account balance equals the carrying amount or net book value of the plant and equipment asset that is reported on the balance sheet. Let’s work through two examples to demonstrate deprecia on adjustments. Big Dog Carworks Corp.’s January 31, 2015 unadjusted trial balance showed the following two plant and equipment assets: Big Dog Carworks Corp. Unadjusted Trial Balance At January 31, 2015 Acct. Account Debit Credit 183 Equipment 3,000 184 Truck 8,000  3.2. Adjus ng Entries 109 The equipment was purchased for $3,000. The Equipment gen- The balance resulted when eral ledger account this journal entry was appears as follows: recorded: Equipment 3,000 Equipment 3,000 Cash 3,000 The equipment was recorded as a plant and equipment asset because it has an es mated useful life greater than 1 year. Assume its actual useful life is 10 years (120 months) and the equipment is es mated to be worth $0 at the end of its useful life (residual value of $0). Cost − Es mated Residual Value $3,000 − $0 = = $25/month Es mated Useful Life 120 months Note that deprecia on is always rounded to the nearest whole dollar. This is because depreci- a on is based on es mates — an es mated residual value and an es mated useful life; it is not exact. The following adjus ng journal entry is made on January 31: General Journal Date Account/Explana on PR Debit Credit Jan 31 Deprecia on Expense, Equipment....... 25 Accumulated Deprecia on, Equipment 25 To adjust for one month of deprecia on on the equipment. When the adjus ng entry is posted, the accounts appear as follows: Accumulated Deprecia on Equipment Deprecia on – Equipment Expense – Equipment 3,000 25 25 The Equipment ac- A contra account, Ac- Deprecia on Expense is in- count remains un- cumulated Deprecia- creased by $25, the amount of changed by the ad- on, is increased by the equipment’s cost that has jus ng entry. $25. been allocated to expense. For financial statement repor ng, the asset and contra asset accounts are combined. The net book value of the equipment on the balance sheet is shown as $2,975 ($3,000 – $25). BDCC also shows a truck for $8,000 on the January 31, 2015 unadjusted trial balance.  110 Financial Accoun ng and Adjus ng Entries The Truck general The journal entry to record ledger accounts ap- the purchase of the truck pears as: was: Truck 8,000 Truck 8,000 Bank Loan 5,000 Cash 3,000 Assume the truck has an es mated useful life of 80 months and a zero es mated residual value. At January 31, one month of the truck cost has expired since it was put into opera on in January. Using the straight-line method, deprecia on is calculated as: Cost − Es mated Residual Value $8,000 − $0 = = $100/month Es mated Useful Life 80 months The adjus ng entry recorded on January 31 is: General Journal Date Account/Explana on PR Debit Credit Jan 31 Deprecia on Expense, Truck............ 100 Accumulated Deprecia on, Truck..... 100 To adjust for one month of deprecia on on the truck. When the adjus ng entry is posted, the accounts appear as follows: Accumulated Deprecia on Truck Deprecia on – Truck Expense – Truck 8,000 100 100 The Truck account A contra account, Ac- Deprecia on Expense is in- remains unchanged cumulated Deprecia- creased by $100, the amount by the adjus ng en- on, is increased by of the truck’s cost that has try. $100. been allocated to expense. For financial statement repor ng, the asset and contra asset accounts are combined. The net book value of the truck on the balance sheet is shown as $7,900 ($8,000 – $100). If deprecia on adjustments are not recorded, assets on the balance sheet would be overstated. Addi onally, expenses would be understated on the income statement causing net income to be overstated. If net income is overstated, retained earnings on the balance sheet would also be overstated.  3.2. Adjus ng Entries 111 It is important to note that land is a long-lived asset. However, it is not depreciated because it does not get used up over me. Therefore, land is o en referred to as a non-depreciable asset. An explora on is available on the Lyryx site. Log into your Lyryx course to run Deprecia on. Adjus ng for Accrued Revenues Accrued revenues are revenues that have been earned but not yet collected or recorded. For example, a bank has numerous notes receivable. Interest is earned on the notes receivable as me passes. At the end of an accoun ng period, there would be notes receivable where the interest has been earned but not collected or recorded. The adjus ng entry for accrued revenues is: General Journal Date Account/Explana on PR Debit Credit Receivable............................ XXX Revenue........................... XXX To adjust for accrued revenue. For Big Dog Carworks Corp., assume that on January 31, $400 of repair work was completed for a client but it had not yet been collected or recorded. BDCC must record the following adjus ng entry: General Journal Date Account/Explana on PR Debit Credit Jan 31 Accounts Receivable................... 400 Repair Revenue..................... 400 To adjust for accrued revenue. Accounts Receivable Repair Revenue 2,000 10,300 400 400 Bal. 2,400 Bal. 10,700 An asset account, Ac- An income statement counts Receivable, is account, Repair Revenue, increased by the ac- is increased by the $400 crued amount. of accrued revenue. If the adjustment was not recorded, assets on the balance sheet would be understated by $400 and revenues would be understated by the same amount on the income statement. An explora on is available on the Lyryx site. Log into your Lyryx course to run Accrued Revenues.  112 Financial Accoun ng and Adjus ng Entries Adjus ng for Accrued Expenses Accrued expenses are expenses that have been incurred but not yet paid or recorded. For exam- ple, a u lity bill received at the end of the accoun ng period is likely not payable for 2–3 weeks. U li es for the period have been used but have not yet been paid or recorded. The adjus ng entry for accrued expenses is: General Journal Date Account/Explana on PR Debit Credit Expense............................... XXX Payable............................ XXX To adjust for accrued expense. Accruing Interest Expense For Big Dog Carworks Corp., the January 31, 2015 unadjusted trial balance shows a $6,000 bank loan balance. Assume it is a 4%, 60-day bank loan1. It was dated January 3 which means that on January 31, 28 days of interest have accrued (January 31 less January 3 = 28 days) as shown in Figure 3.6. 60–day Note January 3 January 31 March 4 (Maturity date) 28 days of interest has been incurred at January 31 Figure 3.6: Interest Incurred During an Accoun ng Period The formula for calcula ng interest when the term is expressed in days is: Elapsed me in days Interest = Principal × Interest rate × 365 The interest expense accrued at January 31 is calculated as: 28 Interest = $6,000 × 0.04 × = $18 (rounded to nearest whole dollar) 365 1 The maturity date is March 4, 2015 calculated as: January 31 less January 3 = 28 days + 28 days in February = 56 days + 4 days = March 4.  3.2. Adjus ng Entries 113 Interest is normally expressed as an annual rate. Therefore, the 28 days must be divided by the 365 days in a year. Normally all interest calcula ons in this textbook are rounded to two decimal places. However, for simplicity of demonstra ons in this chapter, we will round to the nearest whole dollar. BDCC’s adjus ng entry on January 31 is: General Journal Date Account/Explana on PR Debit Credit Jan 31 Interest Expense....................... 18 Interest Payable.................... 18 To adjust for accrued interest; $6,000 X 4% X 28/365 = $18.41 (rounded to $18 for illustra ve purposes in this chapter). This adjus ng entry enables BDCC to include the interest expense on the January income state- ment even though the payment has not yet been made. The entry creates a payable that will be reported as a liability on the balance sheet at January 31. When the adjus ng entry is posted, the accounts appear as: Interest Expense Interest Payable 18 18 An expense account is Interest payable is es- established to record tablished to record the the debit. credit. On February 28, interest will again be accrued and recorded as: General Journal Date Account/Explana on PR Debit Credit Feb 28 Interest Expense....................... 18 Interest Payable.................... 18 To adjust for accrued interest; $6,000 X 4% X 28/365 = $18.41 (rounded to $18 for illustra ve purposes in this chapter). On March 4 when the bank loan matures, Big Dog will pay the interest and principal and record the following entry:  114 Financial Accoun ng and Adjus ng Entries General Journal Date Account/Explana on PR Debit Credit Mar 4 Interest Expense....................... 3 Interest Payable........................ 36 Bank Loan............................. 6,000 Cash............................... 6039 To record payment of the bank loan and interest; interest expense for March is $6,000 X 4% X 4/365 = $2.63 (rounded to $3 for illustra ve purposes in this chapter). The $36 debit to interest payable will cause the Interest Payable account to go to zero since the liability no longer exists once the cash is paid. No ce that the total interest expense recorded on the bank loan was $39 − $18 expensed in January, $18 expensed in February, and $3 expensed in March. The interest expense was matched to the life of the bank loan. Accruing Income Tax Expense Another adjustment that is required for Big Dog Carworks Corp. involves the recording of cor- porate income taxes. In most jurisdic ons, a corpora on is taxed as an en ty separate from its shareholders. For simplicity, assume BDCC’s income tax due for January 2015 is $500. The adjust- ing entry is at January 31: General Journal Date Account/Explana on PR Debit Credit Jan 31 Income Tax Expense.................... 500 Income Tax Payable................. 500 To adjust for January accrued income tax. When the adjus ng entry is posted, the accounts appear as follows: Income Tax Expense Income Tax Payable 500 500 Income Tax Expense, A liability, Income Tax an income statement Payable, is created at account, is created at January 31. January 31. The above adjus ng entry enables the company to match the income tax expense accrued in Jan- uary to the income earned during the same month. An explora on is available on the Lyryx site. Log into your Lyryx course to run Accrued Expenses.  3.2. Adjus ng Entries 115 An explora on is available on the Lyryx site. Log into your Lyryx course to run Collec on/Payment of Accrual Adjustments in the Next Accoun ng Period. The five types of adjustments discussed in the previous paragraphs are summarized in Figure 3.7. Each of the five steps of adjus ng entries either debits an expense or credits a revenue. Adjust Prepaid assets by recording: Adjust Unearned liabili es by recording: Expense........................ XX Unearned Liability.............. XX Prepaid.................... XX Revenue................... XX To adjust a Prepaid for the amount used. To adjust an Unearned Liability for the amount earned. Adjust Plant and Equipment assets by recording: Adjust for Accrued Revenues by recording: Deprecia on Expense........... XX Receivable..................... XX Accumulated Deprecia on.. XX Revenue................... XX To adjust Plant and Equipment assets for To accrue a revenue. deprecia on. Adjust for Accrued Expenses by recording: Expense........................ XX Liability.................... XX To accrue an expense. 1. An accrued revenue is a revenue that has been earned but has not yet been collected or recorded. 2. An accrued expense is an expense that has been incurred but has not yet been paid or recorded. Figure 3.7: Summary of the Five Types of Adjus ng Entries  116 Financial Accoun ng and Adjus ng Entries 3.3 The Adjusted Trial Balance In the last sec on, adjus ng entries were recorded and posted. As a result, LO3 – Prepare an some account balances reported on the January 31, 2015 unadjusted trial adjusted trial bal- balance in Figure 2 have changed. Recall that an unadjusted trial balance ance and explain reports account balances before adjus ng entries have been recorded and its use. posted. An adjusted trial balance reports account balances a er adjus ng entries have been recorded and posted. Figure 3.8 shows the adjusted trial balance for BDCC at January 31, 2015. In Chapters 1 and 2, the prepara on of financial statements was demonstrated using BDCC’s unad- justed trial balance. We now know that an adjusted trial balance must be used to prepare financial statements. Big Dog Carworks Corp. Adjusted Trial Balance At January 31, 2015 Account Balance Account Debit Credit Cash $3,700 Accounts receivable 2,400 Prepaid insurance 2,200 Equipment 3,000 Accumulated deprecia on – equipment $ 25 Truck 8,000 Accumulated deprecia on – truck 100 Bank loan 6,000 Accounts payable 700 Interest payable 18 Unearned repair revenue 100 Income tax payable 500 Share capital 10,000 Dividends 200 Repair revenue 10,700 Deprecia on expense – equipment 25 Deprecia on expense – truck 100 Rent expense 1,600 Insurance expense 200 Interest expense 18 Salaries expense 3,500 Supplies expense 2,000 Truck opera on expense 700 Income tax expense 500 Total debits and credits $28,143 $28,143 Figure 3.8: BDCC’s January 31, 2015 Adjusted Trial Balance An explora on is available on the Lyryx site. Log into your Lyryx course to run Adjusted Trial Balance.  3.4. Using the Adjusted Trial Balance to Prepare Financial Statements 117 3.4 Using the Adjusted Trial Balance to Prepare Financial State- ments In the last sec on, we saw that the adjusted trial balance is prepared af- LO4 – Use an ter journalizing and pos ng the adjus ng entries. This sec on shows how adjusted trial financial statements are prepared using the adjusted trial balance. balance to pre- pare financial statements.  118 Financial Accoun ng and Adjus ng Entries Big Dog Carworks Corp. Adjusted Trial Balance January 31, 2015 Account Balance Account Debit Credit Cash $ 3,700 Asset accounts, liability ac- Accounts receivable 2,400 counts, and the equity ac- Prepaid insurance 2,200 counts from the statement Equipment 3,000 of changes in equity are Accumulated deprecia on – equipment $ 25 used to prepare the balance Truck 8,000 sheet. Accumulated deprecia on – truck 100 Bank loan 6,000 Accounts payable 700 Interest payable 18 Unearned repair revenue 100 Share capital, dividends, Income tax payable 500 and the net income/loss Share capital 10,000 from the income statement Dividends 200 are used to prepare the Repair revenue 10,700 statement of changes in Deprecia on expense – equipment 25 equity. Deprecia on expense – truck 100 Rent expense 1,600 Revenue and expense ac- Insurance expense 200 counts are used to prepare Interest expense 18 the income statement. Salaries expense 3,500 Supplies expense 2,000 Truck opera on expense 700 Income tax expense 500 Total debits and credits $28,143 $28,143 Figure 3.9: BDCC’s January 31, 2015 Adjusted Trial Balance and Links Among Financial State- ments The income statement is prepared first, followed by the statement of changes in equity as shown below.  Big Dog Carworks Corp. Adjusted Trial Balance At January 31, 2015 Account Debit Credit Cash $ 3,700 Big Dog Carworks Corp. Accounts receivable 2,400 Income Statement Prepaid insurance 2,200 For the Month Ended January 31, 2015 3.4. Using the Adjusted Trial Balance to Prepare Financial Statements Equipment 3,000 Accum. dep. – equipment $ 25 Revenues Truck 8,000 Repair revenue $10,700 Accum. dep. – truck 100 Bank loan 6,000 Expenses Accounts payable 700 Salaries expense $ 3,500 Interest payable 18 Supplies expense 2,000 Unearned revenue 100 Rent expense 1,600 Income tax payable 500 Truck opera on expense 700 Share capital 10,000 Income tax expense 500 Dividends 200 Insurance expense 200 Repair revenue 10,700 Dep. expense – truck 100 Dep. expense – equipment 25 Dep. expense – equipment 25 Dep. expense – truck 100 Interest expense 18 Rent expense 1,600 Total expenses 8,643 Insurance expense 200 Net income $2,057 Interest expense 18 Salaries expense 3,500 Big Dog Carworks Corp. Net income is trans- ferred to the Statement of Supplies expense 2,000 Statement of Changes in Equity Changes in Equity as part Truck opera on expense 700 For the Month Ended January 31, 2015 of retained earnings. Income tax expense 500 $28,143 $28,143 Share Retained Total capital earnings equity Share capital and dividends are trans- Balance at beginning of period $ -0- $ -0- $ -0- 119 ferred to the Statement of Changes in Shares issued 10,000 10,000 Equity. Dividends is part of retained earnings because it is a distribu on of Dividends (200) (200) net income. Net income 2,057 2,057 Balance at end of period $10,000 $1,857 $11,857 The balance sheet can be prepared once the statement of changes in equity is complete. These accounts are used to prepare the Balance Sheet. Big Dog Carworks Corp. Balance Sheet Big Dog Carworks Corp. At January 31, 2015 120 Trial Balance At January 31, 2015 Assets Cash $ 3,700 Financial Accoun ng and Adjus ng Entries Account Debit Credit Accounts receivable 2,400 Cash $ 3,700 Prepaid insurance 2,200 Accounts receivable 2,400 Equipment $3,000 Prepaid insurance 2,200 Less: Accum. dep. 25 2,975 Equipment 3,000 Truck $8,000 Accum. dep. – equipment $ 25 Less: Accum. dep. 100 7,900 Truck 8,000 Total assets $19,175 Accum. dep. – truck 100 Bank loan 6,000 Liabili es Accounts payable 700 Bank loan $ 6,000 Interest payable 18 Accounts payable 700 Unearned revenue 100 Interest payable 18 Income tax payable 500 Unearned repair revenue 100 Share capital 10,000 Income tax payable 500 Dividends 200 Total liabili es $7,318 Repair revenue 10,700 Dep. expense – equipment 25 Equity Dep. expense – truck 100 Share capital $10,000 Rent expense 1,600 Retained earnings 1,857 Insurance expense 200 Total equity 11,857 Interest expense 18 Total liabili es and equity $19,175 Salaries expense 3,500 Supplies expense 2,000 The share capital and retained earnings Truck opera on expense 700 balances are transferred to the balance Income tax expense 500 sheet from the statement of changes in $28,143 $28,143 equity.  3.5. The Accoun ng Cycle 121 No ce how accumulated deprecia on is shown on the balance sheet. An explora on is available on the Lyryx site. Log into your Lyryx course to run Adjustments and Financial Statements. 3.5 The Accoun ng Cycle The concept of the accoun ng cycle was introduced in Chapter 2. The LO5 – Iden fy accoun ng cycle consists of the steps followed each accoun ng period to and explain prepare financial statements. These eight steps are: the steps in the accoun ng Step 1: Transac ons are analyzed and recorded in the general journal cycle. Step 2: The journal entries in the general journal are posted to accounts in the general ledger Step 3: An unadjusted trial balance is prepared to ensure total debits equal total credits Step 4: The unadjusted account balances are analyzed and adjus ng entries are journalized in the general journal and posted to the general ledger Step 5: An adjusted trial balance is prepared to prove the equality of debits and credits Step 6: The adjusted trial balance is used to prepare financial statements Step 7: Closing entries are journalized and posted Step 8: Prepare a post-closing trial balance Steps 1 through 6 were introduced in this and the preceding chapters. Steps 7 and 8 are discussed in the next sec on. An explora on is available on the Lyryx site. Log into your Lyryx course to run Reviewing the Accoun ng Cycle.  122 Financial Accoun ng and Adjus ng Entries 3.6 The Closing Process At the end of a fiscal year, a er financial statements have been prepared, LO6 – Explain the the revenue, expense, and dividend account balances must be zeroed so use of and pre- that they can begin to accumulate amounts belonging to the new fiscal pare closing en- year. To accomplish this, closing entries are journalized and posted. Clos- tries and a post- ing entries transfer each revenue and expense account balance, as well as closing trial bal- any balance in the Dividend account, into retained earnings. Revenues, ex- ance. penses, and dividends are therefore referred to as temporary accounts be- cause their balances are zeroed at the end of each accoun ng period. Bal- ance sheet accounts, such as retained earnings, are permanent accounts because they have a con nuing balance from one fiscal year to the next. The closing process transfers temporary account balances into a perma- nent account, namely retained earnings. The four entries in the closing process are detailed below. Entry 1: Close the revenue accounts to the income summary account A single compound closing entry is used to transfer revenue account balances to the income sum- mary account. The income summary is a checkpoint: once all revenue and expense account bal- ances are transferred/closed to the income summary, the balance in the Income Summary account must be equal to the net income/loss reported on the income statement. If not, the revenues and expenses were not closed correctly. Entry 2: Close the expense accounts to the Income Summary account The expense accounts are closed in one compound closing journal entry to the Income Summary account. All expense accounts with a debit balance are credited to bring them to zero. Their balances are transferred to the Income Summary account as an offse ng debit. A er entries 1 and 2 above are posted to the Income Summary account, the balance in the income summary must be compared to the net income/loss reported on the income statement. If the income summary balance does not match the net income/loss reported on the income statement, the revenues and/or expenses were not closed correctly. Entry 3: Close the income summary to retained earnings The Income Summary account is closed to the Retained Earnings account. This procedure transfers the balance in the income summary to retained earnings. Again, the amount closed from the income summary to retained earnings must always equal the net income/loss as reported on the income statement. Note that the Dividend account is not closed to the Income Summary account because dividends is not an income statement account. The dividend account is closed in Entry 4. Entry 4: Close dividends to retained earnings  3.6. The Closing Process 123 The Dividend account is closed to the Retained Earnings account. This results in transferring the balance in dividends, a temporary account, to retained earnings, a permanent account. The balance in the Income Summary account is transferred to retained earnings because the net income (or net loss) belongs to the shareholders. The closing entries for Big Dog Carworks Corp. are shown in Figure 3.10. GENERAL JOURNAL Page 1 Date Descrip on F Debit Credit 2015 Closing Entries Jan. 31 Repair Revenue 10700 - Income Summary 10700 - To close the revenue account balance. Income Summary 8643 - Deprecia on expense – equipment 25 - Deprecia on expense – truck 100 - Income tax expense 500 - Insurance expense 200 - Interest expense 18 - Rent expense 1600 - Salaries expense 3500 - Supplies expense 2000 - Truck opera on expense 700 - To close expense account balances. Income Summary 2057 - Retained earnings 2057 - To close income summary to retained earnings. Retained Earnings 200 - Dividends 200 - To close dividends to retained earnings. Figure 3.10: Closing Entries Pos ng the Closing Entries to the General Ledger When entries 1 and 2 are posted to the general ledger, the balances in all revenue and expense accounts are transferred to the Income Summary account. The transfer of these balances is shown in Figure 3.11. No ce that a zero balance results for each revenue and expense account a er the closing entries are posted, and there is a $2,057 credit balance in the income summary. The income summary balance agrees to the net income reported on the income statement.  124 Financial Accoun ng and Adjus ng Entries 1. Closing Expense Accounts 2. Closing Revenue Accounts Dep. Expense – Equipment Repair Revenue Bal. 25 25 10,700 10,700 Bal. -0- -0- Bal. Dep. Expense – Truck Bal. 100 100 Bal. -0- Insurance Expense Bal. 200 200 Bal. -0- Income Summary 8,643 10,700 Interest Expense 2,057 Bal. Bal. 18 18 Bal. -0- Rent Expense Bal. 1,600 1,600 Bal. -0- Salaries Expense Bal. 3,500 3,500 Bal. -0- Supplies Expense Bal. 2,000 2,000 Bal. -0- Truck Opera on Expense Bal. 700 700 Bal. -0- Income Taxes Expense Bal. 500 500 Bal. -0- Figure 3.11: Closing Revenue and Expense Accounts When the income summary is closed to retained earnings in the third closing entry, the $2,057 credit balance in the income summary account is transferred into retained earnings as shown in Figure 3.12. As a result, the income summary is le with a zero balance.  3.6. The Closing Process 125 3. Closing the Income Summary Account Income Summary Retained Earnings 8,643 10,700 2,057 2,057 2,057 Bal. Bal. -0- Figure 3.12: Closing the Income Summary Account This example demonstrated closing entries when there was a net income. When there is a net loss, the Income Summary account will have a debit balance a er revenues and expenses have been closed. To close the Income Summary account when there is a net loss, the following closing entry is required: General Journal Date Account/Explana on PR Debit Credit Retained Earnings...................... XX Income Summary................... XX To close the net loss, a debit balance in the income summary, to retained earnings. Finally, when dividends is closed to retained earnings in the fourth closing entry, the $200 debit balance in the Dividends account is transferred into retained earnings as shown in Figure 3.13. A er the closing entry is posted, the Dividends account is le with a zero balance and retained earnings is le with a credit balance of $1,857. No ce that the $1,857 must agree to the retained earnings balance calculated on the statement of changes in equity. 4. Closing the Dividends Account Dividends Retained Earnings 200 200 200 2,057 Bal. -0- 1,857 Bal. Figure 3.13: Closing the Dividends Account An explora on is available on the Lyryx site. Log into your Lyryx course to run Closing Entries. The Post–Closing Trial Balance A post-closing trial balance is prepared immediately following the pos ng of closing entries. The purpose is to ensure that the debits and credits in the general ledger are equal and that all tempo- rary accounts have been closed. The post-closing trial balance for Big Dog Carworks Corp. appears below.  126 Financial Accoun ng and Adjus ng Entries Big Dog Carworks Corp. Post-Closing Trial Balance January 31, 2015 Account Balance Account Debit Credit Cash $ 3,700 Accounts receivable 2,400 Prepaid insurance 2,200 Equipment 3,000 Accumulated deprecia on – equipment $ 25 Truck 8,000 Accumulated deprecia on – truck 100 Only permanent Bank loan 6,000 accounts remain. Accounts payable 700 Interest payable 18 Unearned repair revenue 100 Income taxes payable 500 Share capital 10,000 Retained earnings 1,857 Total debits and credits $19,300 $19,300 Note that only balance sheet accounts, the permanent accounts, have balances and are carried forward to the next accoun ng year. All temporary accounts begin the new fiscal year with a zero balance, so they can be used to accumulate amounts belonging to the new me period. An explora on is available on the Lyryx site. Log into your Lyryx course to run Closing Errors. Summary of Chapter 3 Learning Objec ves LO1 – Explain how the meliness, matching, and recogni on GAAP require the recording of adjus ng entries. Financial statements must be prepared in a mely manner, at minimum, once per fiscal year. For statements to reflect ac vi es accurately, revenues and expenses must be recognized and re- ported in the appropriate accoun ng period. In order to achieve this type of matching, adjus ng entries need to be prepared.  Summary of Chapter 3 Learning Objec ves 127 LO2 – Explain the use of and prepare the adjus ng entries required for prepaid expenses, deprecia on, unearned revenues, accrued revenues, and accrued ex- penses. Adjus ng entries are prepared at the end of an accoun ng period. They allocate revenues and expenses to the appropriate accoun ng period regardless of when cash was received/paid. The five types of adjustments are: Expense.............................. XX Receivable...................... XX Prepaid............................ XX Revenue..................... XX To adjust prepaid for the amount used/expired. To adjust for accrued revenue. Deprecia on Expense.................. XX Expense........................ XX Accumulated Deprecia on........... XX Payable...................... XX To allocate the cost of a plan or equipment To adjust for accrued expense. asset over its useful life. Unearned Revenue.................... XX Revenue........................... XX To adjust unearned amounts for amount earned. LO3 – Prepare an adjusted trial balance and explain its use. The adjusted trial balance is prepared using the account balances in the general ledger a er ad- jus ng entries have been posted. Debits must equal credits. The adjusted trial balance is used to prepare the financial statements. LO4 – Use an adjusted trial balance to prepare financial statements. Financial statements are prepared based on adjusted account balances. LO5 – Iden fy and explain the steps in the accoun ng cycle. The steps in the accoun ng cycle are followed each accoun ng period in the recording and report- ing of financial transac ons. The steps are: 1. Transac ons are analyzed and recorded in the general journal. 2. The journal entries in the general journal are posted to accounts in the general ledger. 3. An unadjusted trial balance is prepared to ensure total debits equal total credits.  128 Financial Accoun ng and Adjus ng Entries 4. The unadjusted account balances are analyzed, and adjus ng entries are journalized in the general journal and posted to the general ledger. 5. An adjusted trial balance is prepared to prove the equality of debits and credits. 6. The adjusted trial balance is used to prepare financial statements. 7. Closing entries are journalized and posted. 8. Prepare a post-closing trial balance. LO6 – Explain the use of and prepare closing entries and a post-closing trial bal- ance. A er the financial statements have been prepared, the temporary account balances (revenues, expenses, and dividends) are transferred to retained earnings, a permanent account, via closing entries. The result is that the temporary accounts will have a zero balance and will be ready to accumulate transac ons for the next accoun ng period. The four closing entries are: Revenue........................... XX Income Summary................ XX To close each revenue to the income summary. Income Summary................... XX Expense........................ XX To close each expense to the income summary. Income Summary................... XX OR Retained Earnings.................. XX Retained Earnings............... XX Income Summary................ XX To close a net income in income summary to To close a net loss in income summary to retained earnings. retained earnings. Retained Earnings.................. XX Dividends....................... XX To close dividends to retained earnings. The post-closing trial balance is prepared a er the closing entries have been posted to the gen- eral ledger. The post-closing trial balance will contain only permanent accounts because all the temporary accounts have been closed. Discussion Ques ons 1. Explain the sequence of financial transac ons that occur con nuously during an accoun ng me period. What is this sequence of ac vi es called?  Discussion Ques ons 129 2. Do you have to wait un l the opera ng cycle is complete before you can measure income using the accrual basis of accoun ng? 3. What is the rela onship between the matching concept and accrual accoun ng? Are rev- enues matched to expenses, or are expenses matched to revenues? Does it ma er one way or the other? 4. What is the impact of the going concern concept on accrual accoun ng? 5. Iden fy three different categories of expenses. 6. What are adjus ng entries and why are they required? 7. Why are asset accounts like Prepaid Insurance adjusted? How are they adjusted? 8. How are plant and equipment asset accounts adjusted? Is the procedure similar to the adjustment of other asset and liability accounts at the end of an accoun ng period? 9. What is a contra account and why is it used? 10. How are liability accounts like Unearned Repair Revenue adjusted? 11. Explain the term accruals. Give examples of items that accrue. 12. Why is an adjusted trial balance prepared? 13. How is the adjusted trial balance used to prepare financial statements? 14. List the eight steps in the accoun ng cycle. 15. Which steps in the accoun ng cycle occur con nuously throughout the accoun ng period? 16. Which steps in the accoun ng cycle occur only at the end of the accoun ng period? Explain how they differ from the other steps. 17. Give examples of revenue, expense, asset, and liability adjustments. 18. In general, income statement accounts accumulate amounts for a me period not exceeding one year. Why is this done? 19. Iden fy which types of general ledger accounts are temporary and which are permanent. 20. What is the income summary account and what is its purpose? 21. What is a post-closing trial balance and why is it prepared?  130 Financial Accoun ng and Adjus ng Entries Exercises EXERCISE 3–1 (LO1,2) Adjus ng Entries The following are account balances of Graham Corpora on: Account Title Amount in Balance Unadjusted a er Trial Balance Adjustment Interest Receivable $ -0- $110 Prepaid Insurance 1,800 600 Interest Payable -0- 90 Salaries Payable -0- 450 Unearned Rent 700 200 Required: a. Enter the unadjusted balance for each account in the following T-accounts: Interest Receiv- able, Prepaid Insurance, Interest Payable, Salaries Payable, Unearned Rent, Interest Earned, Rent Earned, Insurance Expense, Interest Expense, and Salaries Expense. b. Reconstruct the adjus ng entry that must have been recorded for each account. c. Post these adjus ng entries and agree ending balances in each T-account to the adjusted balances above. d. List revenue and expense amounts for the period. EXERCISE 3–2 (LO1,2) Adjus ng Entries The trial balance of Lauer Corpora on at December 31, 2015 follows, before and a er the pos ng of adjus ng entries.  Exercises 131 Trial Balance Adjustments Adjusted Trial Balance Dr. Cr. Dr. Cr. Dr. Cr. Cash $4,000 $4,000 Accounts Receivable 5,000 5,000 Prepaid Insurance 3,600 3,300 Prepaid Rent 1,000 500 Truck 6,000 6,000 Accumulated Deprecia on $ -0- $1,500 Accounts Payable 7,000 7,400 Salaries Payable 1,000 Unearned Rent 1,200 600 Share Capital 2,700 2,700 Revenue 25,000 25,000 Rent Earned 600 Adver sing Expense 700 700 Commissions Expense 2,000 2,000 Deprecia on Expense 1,500 Insurance Expense 300 Interest Expense 100 500 Rent Expense 5,500 6,000 Salaries Expense 8,000 9,000 Totals $35,900 $35,900 $38,800 $38,800 Required: a. Indicate in the “Adjustments” column the debit or credit difference between the unadjusted trial balance and the adjusted trial balance. b. Prepare in general journal format the adjus ng entries that have been recorded. Include descrip ons. EXERCISE 3–3 (LO1,2) Adjus ng Entries The following data are taken from an unadjusted trial balance at December 31, 2015: Prepaid Rent $ 600 Office Supplies 700 Income Taxes Payable -0- Unearned Commissions 1,500 Salaries Expense 5,000  132 Financial Accoun ng and Adjus ng Entries Addi onal Informa on: (a) The prepaid rent consisted of a payment for three months’ rent at $200 per month for Decem- ber 2015, January 2016, and February 2016. (b) Office supplies on hand at December 31, 2015 amounted to $300. (c) The es mated income taxes for 2015 are $5,000. (d) All but $500 in the Unearned Commissions account has been earned in 2015. (e) Salaries for the last three days of December amoun ng to $300 have not yet been recorded. Required: a. Prepare all necessary adjus ng entries in general journal format. b. Calculate the cumula ve financial impact on assets, liabili es, equity, revenue and expense if these adjus ng entries are not made. EXERCISE 3–4 (LO1,2) Adjus ng Entries The following are general ledger accounts extracted from the records of Bernard Inc. at December 31, 2015, its year-end (‘Bal’ = unadjusted balance):  Exercises 133 Prepaid Adver sing Accounts Payable Share Capital Bal. 1,000 500 Bal. 15,000 Bal. 8,000 200 100 Subscrip on Revenue Unused Supplies 400 5,000 Bal. 750 400 800 Adver sing Expense Salaries Payable 500 Equipment 700 Bal. 21,750 Unearned Subscrip ons Commissions Expense Acc. Dep’n – Equipment 5,000 Bal. 10,000 800 Bal. 1,500 250 Dep’n Expense – Equipment 250 Maintenance Expense 200 Salaries Expense Bal. 9,500 700 Supplies Expense Bal. 2,500 400 Telephone Expense 100 U li es Expense 400 Required: Prepare in general journal format the adjus ng entries that were posted. Include plau- sible descrip ons/narra ves for each adjustment. EXERCISE 3–5 (LO1,2) Adjus ng Entries The following unadjusted accounts are extracted from the general ledger of A Corp. at December 31, 2015:  134 Financial Accoun ng and Adjus ng Entries Truck Deprecia on Expense – Truck Acc. Dep’n – Truck 10,000 1,300 1,300 Addi onal Informa on: The truck was purchased January 1, 2015. It has an es mated useful life of 4 years. Required: Prepare the needed adjus ng entry at December 31, 2015. EXERCISE 3–6 (LO1,2) Adjus ng Entries The following unadjusted accounts are taken from the records of B Corp. at December 31, 2015: Bank Loan Interest Expense Interest Payable 12,000 1,100 100 Addi onal Informa on: The bank loan was received on January 1, 2015. It bears interest at 10 per cent. Required: Prepare the adjus ng entry at December 31, 2015. EXERCISE 3–7 (LO1,2) Adjus ng Entries The following general ledger accounts and addi onal informa on are taken from the records of Wolfe Corpora on at the end of its fiscal year, December 31, 2015. Cash 101 Unused Supplies 173 Adver sing Exp. 610 Bal. 2,700 Bal. 700 Bal. 200 Accounts Receivable 110 Share Capital 320 Salaries Expense 656 Bal. 2,000 Bal. 3,800 Bal. 4,500 Prepaid Insurance 161 Repair Revenue 450 Telephone Expense 669 Bal. 1,200 Bal. 7,750 Bal. 250 Addi onal Informa on: (a) The prepaid insurance is for a one-year policy, effec ve July 1, 2015. (b) A physical count indicated that $500 of supplies is s ll on hand.  Exercises 135 (c) A $50 December telephone bill has been received but not yet recorded. Required: Record all necessary adjus ng entries in general journal format. EXERCISE 3–8 (LO2) Adjus ng Entries Below are descrip ons of various monthly adjus ng entries: 1. Adjus ng entry for revenue earned but not yet billed to the customer. 2. Adjus ng entry for cash received from a customer for revenue not yet earned. 3. Adjus ng entry for revenue earned that was originally received as cash in advance in the pre- vious month. 4. Adjus ng entry for services received from a supplier, but not yet paid. 5. Adjus ng entry for cash paid to a supplier for repair services not yet received. 6. Adjus ng entry for repair services received that was originally paid as cash in advance to the supplier in the previous month. 7. Adjus ng entry for salaries earned by employees, but not yet paid. 8. Adjus ng entry for annual deprecia on expense for equipment. Required: For each descrip on above, iden fy the likely journal entry debit and credit account. EXERCISE 3–9 (LO2) Adjus ng Entries Turner Empire Co. employs 65 employees. The employees are paid every Monday for work done from the previous Monday to the end-of-business on Friday, or a 5-day work week. Each employee earns $80 per day. Required: 1. Calculate the total weekly payroll cost and the salary adjustment at March 31, 2016. 2. Prepare the adjus ng entry at March 31, 2016. 3. Prepare the subsequent cash entry on April 4, 2016.  136 Financial Accoun ng and Adjus ng Entries EXERCISE 3–10 (LO1,2,3) Adjus ng Entries Below is a trial balance for Quer n Quick Fix Ltd. at October 31, 2016 with three sets of debit/credit columns. The first set is before the October month-end adjus ng entries, and the third column is a er the October month-end adjus ng entries. Quer n Quick Fix Ltd. Trial Balance At October 31, 2016 Unadjusted Trial Balance Adjustments Adjusted Trial Balance Debit Credit Debit Credit Debit Credit Accounts payable $225,000 $225,500 Accounts receivable $325,000 $395,000 Accrued salaries payable 5,000 9,500 Accumulated deprec