Chapter 3Adjusting Accounts and Preparing Financial Statements1. The cash basis of accounting reports revenues when cash is received while theaccrual basis reports revenues when they are earned. The cash basis reports expenses when cash is paid while the accrual basis reports expenses when they are incurred and matched with revenues they generated.2. The accrual basis of accounting generally provides a better indication of companyperformance and financial condition than does the cash basis. Also, the accrual basis increases the comparability of financial statements from one period to the next.Thus, business decision makers generally prefer the accrual basis.3. Businesses that have major seasonal variations in sales are most likely to select thenatural business year as the fiscal year.4. A prepaid expense is an item paid for in advance of receiving its benefits. As such, itis reported as an asset on the balance sheet.5. Long-term tangible plant assets such as equipment, buildings, and machinery leadto adjustments for depreciation. Generally, land is the only long-term tangible plant asset that does not require depreciation.6. The Accumulated Depreciation contra account is used for depreciation. It providesfinancial statement users with additional information about the relative age of the assets. Without the contra account information, the reader would not be able to tell whether the assets are new or in need of replacement.7. Unearned revenue refers to cash received in advance of providing products andservices. Another name for unearned revenue is deferred revenue. It is reported asa liability on the balance sheet.8. Accrued revenue is revenue that is earned but is not yet received in cash (and/orother assets) and the customer has not been billed prior to the end of the period.Therefore, end-of-period adjustments are made to record accrued revenue.Examples are interest income that has been earned but not collected and revenues from services performed that are neither collected nor billed.9.A If prepaid expenses are initially recorded with debits to expense accounts, then theprepaid expenses asset accounts are debited in the adjusting entries.10. For Best Buy, all of the accounts under the category of Property and Equipment(except for Land), require adjusting entries. The expense related to the depreciation expense account would be understated on the income statement if Best Buy fails to adjust these asset accounts. If the adjusting entries are not made, net income would be overstated. Note: Students might also correctly identify accounts receivable, goodwill, and tradenames as needing adjustment.11. Circuit City must make adjusting entries to Prepaid expenses and other currentassets; Deferred income taxes; Accrued expenses and other current liabilities;Accrued income taxes; and possibly other assets and liabilities such as Receivables for bad debts. (It is also possible that Circuit City would need to adjust Goodwill and Other intangible assets.)12. RadioShack would need to debit interest receivable and credit interest revenue.13. The Accrued Wages Expense would be reported as part of ―Accrued Expenses‖ onApple’s balance sheet.Quick Study 3-1 (15 minutes)Cash AccountingRevenues (cash receipts) ...................................................... $52,000Expenses (cash payments: $37,500 - $6,000 + $3,250) ...... 34,750Net income ............................................................................. $17,250 Accrual AccountingRevenues (earned) ................................................................ $60,000Expenses (incurred) .............................................................. 37,500Net income .............................................................................. $22,500Quick Study 3-2 (10 minutes)a. AE Accrued expensesb. PE Prepaid expensesc. UR Unearned revenuesd. PE Prepaid expenses (Depreciation)e. AR Accrued revenuesa. Debit Unearned Revenue Balance SheetCredit Revenue Earned Income Statementb. Debit Wages Expense Income StatementCredit Wages Payable Balance Sheetc. Debit Accounts Receivable Balance SheetCredit Revenue Earned Income Statementd. Debit Insurance Expense Income StatementCredit Prepaid Insurance Balance Sheete. Debit Depreciation Expense Income StatementCredit Accumulated Depreciation Balance SheetQuick Study 3-4 (15 minutes)a. Insurance Expense ....................................................... 3,000Prepaid Insurance ................................................. 3,000 To record 6-month insurance coverage expired.b. Supplies Expense ......................................................... 4,150Supplies .................................................................. 4,150 To record supplies used during the year.($900 + $4,000 – [?] = $750)Quick Study 3-5 (15 minutes)a. Depreciation Expense—Equipment ............................ 8,400Accumulated Depreciation—Equipment ............. 8,400 To record depreciation expense for the year.($45,000 - $3,000) / 5 years = $8,400b. No depreciation adjustments are made for land asit is expected to last indefinitely.Salaries Expense (400)Salaries Payable (400)To record salaries incurred but not yet paid.[One student earns $100 x 4 days, Mondaythrough Thursday]Quick Study 3-7 (15 minutes)a. Unearned Revenue ........................................................ 22,500Legal Revenue ....................................................... 22,500 To recognize legal revenue earned (30,000 x 3/4).b. Unearned Subscription Revenue ................................ 1,200Subscription Revenue ........................................... 1,200 To recognize subscription revenue earned.[100 x ($24 / 12 months) x 6 months]Quick Study 3-8 (15 minutes)1. Accrue salaries expense e ga f2. Adjust the Unearned Services Revenue accountto recognize earned revenueb f3. Record the earning of services revenue for whichcash will be received the following periodQuick Study 3-9 (10 minutes)The answer is a.ExplanationThe debit balance in Prepaid Insurance was reduced by $400, implying a $400 debit to Insurance Expense. The credit balance in Interest Payable increased by $800, implying an $800 debit to Interest Expense.Quick Study 3-10 (15 minutes)The answer is 2.ExplanationInsurance premium errorUnderstates expenses (and overstates assets) by .......... $1,600 Accrued salaries errorUnderstates expenses (and understates liabilities) by .... 1,000The collective effects from this company’s errors follow:Understates expenses by ..................................................... $2,600Overstates assets by ............................................................. $1,600Understates liabilities by ...................................................... $1,000Quick Study 3-11 (10 minutes)Profit margin = $78,750 / $630,000 = 12.5%Interpretation: For each dollar that Miller Company records as revenue, it earns 12.5 cents in net income. Miller’s 12.5% is markedly lower than competitors’ average profit margin of 15%—it must improve performance. Quick Study 3-12A (5 minutes)The answer is c.Exercise 3-1 (10 minutes)1. B 4. A2. F 5. D3. C 6. EExercise 3-2 (25 minutes)a. Depreciation Expense—Equipment ................................ 16,000Accumulated Depreciation—Equipment..................... 16,000 To record depreciation expense for the year.b. Insurance Expense ........................................................... 5,360Prepaid Insurance* ....................................................... 5,360 To record insurance coverage that expired($6,000 - $640).c. Office Supplies Expense .................................................. 3,422Office Supplies**............................................................ 3,422 To record office supplies used ($325 + $3,480 - $383).d. Unearned Fee Revenue .................................................... 3,000Fee Revenue .................................................................. 3,000 To record earned portion of fee received in advance($15,000 x 1/5).e. Insurance Expense ........................................................... 6,160Prepaid Insurance ......................................................... 6,160 To record insurance coverage that expired.f. Wages Expense ................................................................. 2,700Wages Payable .............................................................. 2,700 To record wages accrued but not yet paid.a. Unearned Fee Revenue .................................................... 5,000Fee Revenue .................................................................. 5,000 To record earned portion of fee received in advance($15,000 x 1/3).b. Wages Expense ................................................................. 7,500Wages Payable .............................................................. 7,500 To record wages accrued but not yet paid.c. Depreciation Expense—Equipment ................................ 17,251Accumulated Depreciation—Equipment..................... 17,251 To record depreciation expense for the year.d. Office Supplies Expense .................................................. 5,682Office Supplies*............................................................. 5,682 To record office supplies used ($240 + $6,102 - $660).e. Insurance Expense ........................................................... 2,700Prepaid Insurance†........................................................ 2,700 To record insurance coverage expired ($4,000 - $1,300).f. Interest Receivable ......................................................... 1,400Interest Revenue ........................................................ 1,400 To record interest earned but not yet received.g. Interest Expense ............................................................. 2,000Interest Payable........................................................... 2,000 To record interest incurred but not yet paid.Notes:a. Adjusting entry2009Dec. 31 Wages Expense (825)Wages Payable (825)To record accrued wages for one day.(5 workers x $165)b. Payday entry2010Jan. 4 Wages Expense.......................................................2,475Wages Payable (825)Cash .....................................................................3,300To record accrued and current wages.Wages expense = 5 workers x 3 days x $165Cash = 5 workers x 4 days x $165Exercise 3-5 (15 minutes)a. $ 2,000b. $ 6,607c. $11,987d. $ 1,375Proof: (a) (b) (c) (d) Supplies available – prior year-end ......... $ 350 $1,855 $ 1,576 $1,375 Supplies purchased in current year ........ 2,450 6,307 11,987 6,907 Total supplies available ............................ 2,800 8,162 13,563 8,282 Supplies available – current year-end ..... (800) (6,607) (2,056) (800) Supplies expense for current year........... $2,000 $1,555 $11,507 $7,482a.Apr. 30 Legal Fees Expense ........................................... 4,500Legal Fees Payable ..................................... 4,500 To record accrued legal fees.May 12 Legal Fees Payable ............................................ 4,500Cash ............................................................. 4,500 To pay accrued legal fees.b.Apr. 30 Interest Expense ................................................. 1,900Interest Payable .......................................... 1,900 To record accrued interest expense($5,700 x 10/30).May 20 Interest Payable .................................................. 1,900Interest Expense ................................................. 3,800Cash ............................................................. 5,700 To record payment of accrued and currentinterest expense ($5,700 x 20/30).c.Apr. 30 Salaries Expense ................................................ 4,800Salaries Payable.......................................... 4,800 To record accrued salaries($12,000 x 2/5 week).May 3 Salaries Payable ................................................. 4,800Salaries Expense ................................................ 7,200Cash ............................................................. 12,000 To record payment of accrued andcurrent salaries ($12,000 x 3/5 week).Basis*Basis Basis**Basis Dec. 31, 2007 ........$14,450 $0 2007 ..........$ 850 $15,300 Dec. 31, 2008 ........9,350 0 2008 ..........5,100 0 Dec. 31, 2009 ........4,250 0 2009 .......... 5,100 0 Dec. 31, 2010 ........0 0 2010 .......... 4,250 0$15,300 $15,300Explanations:*Accrual asset balance equals months left in the policy x $425 per month (monthly cost is computed as $15,300 / 36 months).Months Left Balance12/31/2007 .. 34 $14,45012/31/2008 .. 22 9,35012/31/2009 .. 10 4,25012/31/2010 .. 0 0**Accrual insurance expense equals months covered in the year x $425 per month.Months Covered Expense2007 ............ 2 $ 8502008 ............12 5,1002009 ............12 5,1002010 ............10 4,250$15,300Exercise 3-8 (25 minutes)Dec. 31 Accounts Receivable ............................................. 1,980Fees Earned ..................................................... 1,980 To record earned but unbilled fees (30% x $6,600).31 Unearned Fees ........................................................ 4,620Fees Earned ..................................................... 4,620 To record earned fees collected in advance(70% x $6,600).31 Depreciation Expense—Computers ..................... 1,650Accumulated Depreciation-Computers ........ 1,650 To record depreciation on computers.31 Depreciation Expense—Office Furniture ............. . 1,925A ccumulated Depreciation—Office Furniture ... 1,925To record depreciation on office furniture.31 Salaries Expense .................................................... 2,695Salaries Payable.............................................. 2,695 To record accrued salaries.31 Insurance Expense.................................................. 1,430Prepaid Insurance ........................................... 1,430 To record expired prepaid insurance.31 Rent Expense (700)Rent Payable (700)To record accrued rent expense.31 Office Supplies Expense (528)Office Supplies (528)To record use of office supplies.31 Advertising Expense (500)Advertising Payable (500)To record accrued advertising expense.31 Utilities Expense (77)Utilities Payable (77)To record incurred and unpaid utility costs.Exercise 3-9 (10 minutes)a. $ 6,039 / $ 52,970 = 11.4%b. $100,890 / $ 471,430 = 21.4%c. $106,880 / $ 301,920 = 35.4%d. $ 67,140 / $1,721,520 = 3.9%e. $ 84,780 / $ 513,800 = 16.5%Analysis and Interpretation: Company c has the highest profitability according to the profit margin ratio. Company c earns 35.4 cents in net income for every one dollar of net sales earned.Exercise 3-10A (30 minutes)a.Dec. 1 Supplies Expense ................................................... 2,000Cash ................................................................. 2,000 Purchased supplies.b.Dec. 2 Insurance Expense ................................................. 1,540Cash ................................................................. 1,540 Paid insurance premiums.c.Dec. 15 Cash ......................................................................... 13,000Remodeling Fees Earned ............................... 13,000 Received fees for work to be done.d.Dec. 28 Cash ......................................................................... 3,700Remodeling Fees Earned ............................... 3,700 Received fees for work to be done.e.Dec. 31 Supplies .................................................................. 1,840Supplies Expense ........................................... 1,840 Adjust expenses for unused supplies.f.Dec. 31 Prepaid Insurance .................................................. 1,200Insurance Expense ......................................... 1,200 Adjust expenses for unexpired coverage($1,540 - $340).g.Dec. 31 Remodeling Fees Earned ..................................... 11,130Unearned Remodeling Fees .......................... 11,130 Adjusted revenues for unfinished projects($13,000 + 3,700 - $5,570).Exercise 3-11A (25 minutes)a. Initial credit recorded in the Unearned Fees accountJuly 1 Cash ....................................................................... 2,800Unearned Fees .............................................. 2,800 Received fees for work to be done for Solana.6 Cash ....................................................................... 8,100Unearned Fees .............................................. 8,100 Received fees for work to be done for Haru.12 Unearned Fees ...................................................... 2,800Fees Earned ................................................... 2,800 Completed work for Solana.18 Cash ....................................................................... 7,300Unearned Fees .............................................. 7,300 Received fees for work to be done for Jordan.27 Unearned Fees ...................................................... 8,100Fees Earned ................................................... 8,100 Completed work for customer Haru.31 No adjusting entries required.b. Initial credit recorded in the Fees Earned accountJuly 1 Cash ....................................................................... 2,800Fees Earned ................................................... 2,800 Received fees for work to be done for Solana.6 Cash ....................................................................... 8,100Fees Earned ................................................... 8,100 Received fees for work to be done for Haru.12 No entry required.18 Cash ....................................................................... 7,300Fees Earned ................................................... 7,300 Received fees for work to be done for Jordan.27 No entry required.31 Fees Earned .......................................................... 7,300Unearned Fees .............................................. 7,300 Adjusted to reflect unearned fees for unfinishedjob for Jordan.Exercise 3-11A–concludedc. Under the first method (and using entries from a)Unearned Fees = $2,800 + $8,100 - $2,800 + $7,300 - $8,100 = $7,300 Fees Earned = $2,800 + $8,100 = $10,900Under the second method (and using entries from b)Unearned Fees = $7,300Fees Earned = $2,800 + $8,100 + $7,300 - $7,300 = $10,900[Note: Both procedures yield identical results in the financial statements.]Problem 3-1A (10 minutes)1. I 5. G 9. H2. D 6. C 10. E3. F 7. I 11. H4. B 8. A 12. BProblem 3-2A (35 minutes)Part 1Adjustment (a)Dec. 31 Office Supplies Expense ................................ 12,325Office Supplies ......................................... 12,325 To record cost of supplies used($2,900 + $11,977 - $2,552).Adjustment (b)31 Insurance Expense .......................................... 12,280Prepaid Insurance .................................... 12,280To record annual insurance coverage cost.B 290 ($10,440/36 mo.) 9 2,610C 770 ($ 9,240 /12 mo.) 5 3,850Total $12,280Adjustment (c)31 Salaries Expense ............................................. 3,660Salaries Payable....................................... 3,660 To record accrued but unpaid wages(2 days x $1,830).Problem 3-2A −concludedAdjustment (d)Dec. 31 Depreciation Expense—Building ................... 18,875Accumulated Depreciation—Building ... 18,875 To record annual depreciation expense[($800,000 -$45,000) / 40 years = $18,875]Adjustment (e)31 Rent Receivable ............................................ 3,000Rent Earned ........................................... 3,000 To record earned but unpaid Dec. rent.Adjustment (f)31 Unearned Rent .............................................. 5,436Rent Earned ........................................... 5,436 To record the amount of rent earned forNovember and December (2 x $2,718).Part 2Cash Payment for (c)Jan. 6 Salaries Payable ........................................... 3,660Salaries Expense* ........................................ 5,490Cash ....................................................... 9,150 To record payment of accrued andcurrent salaries. *(3 days x $1,830)Cash Payment for (e)15Cash ............................................................... 6,000Rent Receivable .................................... 3,000Rent Earned ........................................... 3,000 To record past due rent for two months.Parts 1 and 2Part 2Adjustment (a)Dec. 31 Insurance Expense ...............................................3,000Prepaid Insurance ...........................................3,000 To record the insurance expired.Adjustment (b)31 Teaching Supplies Expense ................................9,000Teaching Supplies ..........................................9,000 To record supplies used ($11,000 - $2,000).Adjustment (c)31 Depreciation Expense—Equipment ....................10,000Accumulated Depreciation—Equipment ............10,000 To record equipment depreciation.Adjustment (d)31 Depreciation Expense—Profess. Library ...........5,000A ccumul. Depreciation—Profess. Library.........5,000To record professional library depreciation.Adjustment (e)31 Unearned Training Fees .......................................5,000Training Fees Earned .....................................5,000 To record 2 months’ training fees earnedthat were collected in advance.Adjustment (f)31 Accounts Receivable ............................................4,000Tuition Fees Earned........................................4,000 To record tuition earned($1,600 x 2 1/2 months).Adjustment (g)31 Salaries Expense (480)Salaries Payable (480)To record accrued salaries(2 days x $120 x 2 employees).Adjustment (h)31 Rent Expense ........................................................2,178Prepaid Rent ....................................................2,178 To record expiration of prepaid rent.Part 3WELLS TEACHING INSTITUTEAdjusted Trial BalanceDecember 31, 2009Debit Credit Cash .......................................................................... $ 28,064Accounts receivable ................................................ 4,000Teaching supplies ................................................... 2,000Prepaid insurance .................................................... 13,000Prepaid rent 0Professional library ................................................. 33,000 Accumulated depreciation—Professional library ... $ 15,000 Equipment ................................................................ 75,800 Accumulated depreciation—Equipment ................ 25,000 Accounts payable .................................................... 39,500 Salaries payable . (480)Unearned training fees ............................................ 7,500 T. Wells, Capital ....................................................... 71,000 T. Wells, Withdrawals .............................................. 44,000Tuition fees earned .................................................. 115,000 Training fees earned ................................................ 46,000 Depreciation expense—Professional library ........ 5,000 Depreciation expense—Equipment ....................... 10,000Salaries expense ..................................................... 52,480Insurance expense................................................... 3,000Rent expense ............................................................ 26,136Teaching supplies expense .................................... 9,000 Advertising expense ................................................ 8,000Utilities expense....................................................... 6,000 _______ Totals ........................................................................ $319,480 $319,480Part 4WELLS TEACHING INSTITUTEIncome StatementFor Year Ended December 31, 2009RevenuesTuition fees earned ............................................ $115,000Training fees earned .......................................... 46,000Total revenues .................................................... $161,000 ExpensesDepreciation expense—Professional library ... 5,000Depreciation expense—Equipment .................. 10,000Salaries expense ................................................ 52,480Insurance expense ............................................. 3,000Rent expense ...................................................... 26,136Teaching supplies expense ............................... 9,000Advertising expense .......................................... 8,000Utilities expense ................................................. 6,000Total expenses ................................................... 119,616 Net income ............................................................ $ 41,384WELLS TEACHING INSTITUTEBalance SheetDecember 31, 2009AssetsCash ................................................................................. $ 28,064 Accounts receivable ...................................................... 4,000 Teaching supplies .......................................................... 2,000 Prepaid insurance .......................................................... 13,000 Professional library ........................................................ $33,000 Accumulated depreciation—Professional library ....... (15,000) 18,000 Equipment ....................................................................... 75,800 Accumulated depreciation—Equipment ...................... (25,000) 50,800 Total assets ..................................................................... $115,864LiabilitiesAccounts payable ........................................................... $ 39,500 Salaries payable . (480)Unearned training fees .................................................. 7,500 Total liabilities ................................................................ 47,480EquityT. Wells, Capital .............................................................. 68,384 Total liabilities and equity ............................................. $115,864Problem 3-4A (45 minutes) —Part 1Cash ......................................... $ 86,000 $ 86,000 Accounts receivable ........... 15,000 (a) 4,000 19,000Office supplies ...................... 17,800 (b) 8,800 9,000Prepaid insurance ................ 6,040 (c) 2,080 3,960Office equipment .................. 87,000 87,000 Accumulated depreciation—Office equipment ........... $ 24,000 (d) 2,000 $ 26,000 Accounts payable ................ 9,100 (e) 14,900 24,000 Interest payable ..................... (f) 2,500 2,500 Salaries payable ................... (g) 15,000 15,000 Unearned consulting fees .20,000 (h) 7,000 13,000 Long-term notes payable .. 54,000 54,000 K. Jenkins, Capital ............... 46,000 46,000 K. Jenkins, Withdrawals .... 10,000 10,000Consulting feesearned .................................... 165,000 (a)(h)4,0007,000 176,000Depreciation expense—Office equipment ................ (d) 2,000 2,000Salaries expense .................. 67,990 (g) 15,000 82,990Interest expense ................... 1,270 (f) 2,500 3,770 Insurance expense .............. (c) 2,080 2,080Rent expense ........................ 14,540 14,540Office supplies expense .... (b) 8,800 8,800 Advertising expense ........... 12,460 _______ (e) 14,900 ______ 27,360 _______ Totals ........................................ $318,100 $318,100 $56,280 $56,280 $356,500 $356,500Adjustment description(a) Earned but uncollected revenues.(b) Cost of office supplies used.(c) Cost of expired insurance coverage.(d) Depreciation expense on office equipment.(e) Incurred but unpaid advertising expense.(f) Incurred but unpaid interest expense.(g) Incurred but unpaid salaries expense.(h) Earned revenues previously received in advance.。