Chapter 5: Adjustments and the Worksheet

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1 Chapter 5: Adjustments and the Worksheet Chapter Opener: Thinking Critically Students should suggest that accountants estimate the amount of wear and tear on the equipment. This expense should be charged against the income earned during that same period. The concept of adjustments and depreciation can be introduced at this time. Fast Facts William Boeing founded Pacific Aero Products Company in 1916; the name was changed to Boeing in In 1917 the company employed 28 people. In 2004 Boeing employed more than 159,000 people in 48 U.S. states and 67 foreign countries. Boeing is the largest contractor working for NASA. Along with the ISS, the Boeing Company manufactures and services commercial airplanes, military aircraft, helicopters, a variety of electronic defense systems, and advanced communication systems. Boeing s newest division, Connexion, equips aircraft with a broadband connection that provides highspeed access to the Internet, entertainment and television all in real-time. Boeing s 2004 sales were $52.5 billion from customers in 145 countries. International sales accounted for nearly 30 percent of total sales. Computers in Accounting: Thinking Critically Answers will vary, but students should demonstrate an understanding of the word integrated as it applies to computerized accounting systems. Each accounting module (accounts payable, accounts receivable, general ledger, fixed asset, etc.) communicates with the others, transferring data, keeping the entire system in balance. Computers in Accounting: Internet Application Students can find information at Reports will vary. The Accu-Books general ledger module provides the following features: produces financial reports, offers customizable chart of accounts, and provides easy-to-use forms for journal entries. Managerial Implications: Thinking Critically Adjustments ensure that the financial statements reflect the true condition and performance of the business. Discussion Questions These questions are designed to check students understanding of new terms, concepts, and procedures presented in the chapter. 1. Debit Depreciation Expense Machine, $125; Credit Accum. Depr. Machine, $ Debit Insurance Expense; credit Prepaid Insurance. 3. Expense items that are acquired and paid for in advance of their use. Supplies, prepaid rent, prepaid insurance, and advertising. 4. Update supplies accounts at the end of a period to reflect amounts used. 5. b, d, f, g, and i are depreciated. 6. a. none b. none c. none d. decrease 7. a. decrease b. none c. none d. decrease 8. To create a permanent record of any changes in account balances that are shown on the worksheet. 9. Asset cost, accumulated depreciation, book value. 10. Contra asset accounts have a credit balance. Asset accounts have a debit balance. 11. Cost of asset less accumulated depreciation. 12. To keep a record of total depreciation taken; to reduce the book value of asset. 13. Charges off an equal amount of cost of asset during each accounting period in asset s useful life. 14. Equipment, buildings, and automobiles. 70 Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

2 Exercises Exercise Rent Expense, $1,500 Dr. Prepaid Rent, $1,500 Cr. ($9,000 6 months = $1,500 per month) 2. Supplies Expense, $1,475 Dr. Supplies, $1,475 Cr. ($2,375 $900 = $1,475) 3. Depreciation Expense Equipment, $225 Dr. Accumulated Depreciation Equipment, $225 Cr. ($27, months = $225) Exercise Insurance Expense, $250 Dr. Prepaid Insurance, $250 Cr. ($6, months = $250 month) 2. Advertising Expense, $450 Dr. Prepaid Advertising, $450 Cr. ($5, months = $450) Exercise 5.3 Mason Company Worksheet (Partial) Month Ended January 31, Trial Adjustments Adjusted Trial Account Name Debit Credit Debit Credit Debit Credit Cash 62,000 62,000 Accounts Receivable 21,500 21,500 Supplies 8,000 (a) 5,200 2,800 Prepaid Insurance 7,200 (b) 1,800 5,400 Equipment 90,500 90,500 Accumulated Depr. Equipment (c) 1,575 1,575 Accounts Payable 15,700 15,700 Jerry Mason, Capital 80,950 80,950 Fees Income 112, ,000 Rent Expense 9,600 9,600 Salaries Expense 9,850 9,850 Supplies Expense (a) 5,200 5,200 Insurance Expense (b) 1,800 1,800 Depreciation Expense Equipment (c) 1,575 1,575 Totals 208, ,650 8,575 8, , ,225 Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 71

3 Exercise 5.4 Net Income Before Adjustments $40,000 Less Adjustments: Rent Expense $3,000 Depreciation Expense ,600 Supplies Expense ,300 Total Adjustments for Expenses Not Made.. 7,900 Corrected Net Income $32,100 If the adjusting entries are not made, total expenses will be understated by $7,900 and net income will be overstated by $7,900. Exercise 5.5 GENERAL JOURNAL PAGE 3 Date Description Ref. Debit Credit Adjusting Entries Dec. 31 Supplies Expense ,500 Supplies , Insurance Expense ,800 Prepaid Insurance , Depreciation Expense Equipment ,200 Accumulated Depreciation Equipment , Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

4 GENERAL LEDGER ACCOUNT Supplies ACCOUNT NO. 121 Dec. 1 J1 4,000 4, Adjusting J3 2,500 1,500 ACCOUNT Prepaid Insurance ACCOUNT NO. 131 Dec. 1 J1 10,800 10, Adjusting J3 1,800 9,000 ACCOUNT Accumulated Depreciation Equipment ACCOUNT NO. 142 Dec. 31 Adjusting J3 1,200 1,200 ACCOUNT Depreciation Expense Equipment ACCOUNT NO. 517 Dec. 31 Adjusting J3 1,200 1,200 ACCOUNT Insurance Expense ACCOUNT NO. 521 Dec. 31 Adjusting J3 1,800 1,800 ACCOUNT Supplies Expense ACCOUNT NO. 523 Dec. 31 Adjusting J3 2,500 2,500 Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 73

5 Problems Problem 5.1A DENTON COMPANY Worksheet Month Ended January 31, Adjusted Income Trial Adjustments Trial Statement Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash 26,000 26,000 26,000 Accounts Receivable 5,200 5,200 5,200 Supplies 9,600 (a) 8,000 1,600 1,600 Prepaid Insurance 15,000 (b) 2,500 12,500 12,500 Equipment 27,000 27,000 27,000 Accumulated Dep. Equipment (c) Accounts Payable 6,200 6,200 6,200 Julie Denton, Capital 63,000 63,000 63,000 Julie Denton, Drawing 3,600 3,600 3,600 Fees Income 25,800 25,800 25,800 Depreciation Expense Equipment (c) Insurance Expense (b) 2,500 2,500 2,500 Salaries Expense 7,800 7,800 7,800 Supplies Expense (a) 8,000 8,000 8,000 Utilities Expense Totals 95,000 95,000 11,050 11,050 95,550 95,550 19,650 25,800 75,900 69,750 Net Income 6,150 6,150 25,800 25,800 75,900 75,900 Analyze: The adjustment to Prepaid Insurance decreased the account balance. 74 Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

6 Problem 5.2A CAMPUS BOOK STORE Worksheet Month Ended November 30, Adjusted Income Trial Adjustments Trial Statement Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash 22,575 22,575 Accounts Receivable 3,312 3,312 Supplies 6,000 (a) 2,400 3,600 Prepaid Rent 21,000 (b) 3,000 18,000 Equipment 27,000 27,000 Accumulated Depreciation Equip. (c) Accounts Payable 8,000 8,000 Chuck Keen, Capital 40,837 40,837 Chuck Keen, Capital, Drawing 3,000 3,000 Fees Income 42,000 42,000 Depreciation Expense Equip. (c) Rent Expense (b) 3,000 3,000 Salaries Expense 7,500 7,500 Supplies Expense (a) 2,400 2,400 Utilities Expense Totals 90,837 90,837 6,100 6,100 91,537 91,537 Analyze: The balance of the Prepaid Rent account prior to the adjusting entry for expired rent is $21,000. Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 75

7 Problem 5.3A OXNARD CORPORATION Income Statement Month Ended December 31, Revenue Fees Income ,750 Expenses Salaries Expense ,400 Utilities Expense Supplies Expense ,000 Advertising Expense ,200 Depreciation Expense Equipment Total Expenses ,100 Net Income ,650 OXNARD CORPORATION Statement of Owner s Equity Month Ended December 31, Derrick Wells, Capital, December 1,. 54,000 Net Income for December ,650 Less Withdrawals for December ,600 Increase in Capital ,050 Derrick Wells, Capital, December 31, 76,050 OXNARD CORPORATION Sheet December 31, Assets Cash ,600 Accounts Receivable ,000 Supplies ,050 Prepaid Advertising ,000 Equipment ,000 Less Accumulated Depreciation ,400 Total Assets ,050 Liabilities & Owner s Equity Liabilities Accounts Payable ,000 Owner s Equity Derrick Wells, Capital ,050 Total Liabilities & Owner s Equity ,050 Analyze: Net income would be $24, Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

8 Problem 5.4A RAMON CREATIVE DESIGNS Worksheet Month Ended January 31, Adjusted Income Trial Adjustments Trial Statement Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash 17,750 17,750 17,750 Accounts Receivable 6,300 6,300 6,300 Supplies 3,875 (a) 3, Prepaid Advertising 4,200 (b) 1,050 3,150 3,150 Prepaid Rent 9,600 (c) 800 8,800 8,800 Equipment 10,800 10,800 10,800 Accumulated Depreciation Equip. (d) Accounts Payable 7,775 7,775 7,775 Carlos Ramon, Capital 30,000 30,000 30,000 Carlos Ramon, Drawing 3,500 3,500 3,500 Fees Income 23,800 23,800 23,800 Advertising Expense (b) 1,050 1,050 1,050 Depreciation Expense Equipment (d) Rent Expense (c) Salaries Expense 4,850 4,850 4,850 Supplies Expense (a) 3,325 3,325 3,325 Utilities Expense Totals 61,575 61,575 5,265 5,265 61,665 61,665 10,815 23,800 50,850 37,865 Net Income 12,985 12,985 23,800 23,800 50,850 50,850 Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 77

9 RAMON CREATIVE DESIGNS Income Statement Month Ended January 31, Revenue Fees Income ,800 Expenses Salaries Expense ,850 Utilities Expense Supplies Expense ,325 Advertising Expense ,050 Rent Expense Depreciation Expense Equipment Total Expenses ,815 Net Income ,985 RAMON CREATIVE DESIGNS Statement of Owner s Equity Month Ended January 31, Carlos Ramon, Capital, January 1,.. 30,000 Net Income for January ,985 Less Withdrawals for January ,500 Increase in Capital ,485 Carlos Ramon, Capital, January 31,. 39,485 RAMON CREATIVE DESIGNS Sheet January 31, Assets Cash ,750 Accounts Receivable ,300 Supplies Prepaid Advertising ,150 Prepaid Rent ,800 Equipment ,800 Less Accumulated Depreciation Equipment ,710 Total Assets ,260 Liabilities and Owner s Equity Liabilities Accounts Payable ,775 Owner s Equity Carlos Ramon, Capital ,485 Total Liabilities and Owner s Equity , Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

10 GENERAL JOURNAL PAGE 3 Date Description Ref. Debit Credit Adjusting Entries Jan. 31 Supplies Expense ,325 Supplies , Advertising Expense ,050 Prepaid Advertising , Rent Expense Prepaid Rent Depreciation Expense Equipment Accumulated Depreciation Equipment GENERAL LEDGER ACCOUNT Supplies ACCOUNT NO. 121 Jan. 1 J1 3,875 3, Adjusting J3 3, ACCOUNT Prepaid Advertising ACCOUNT NO. 130 Jan. 1 J1 4,200 4, Adjusting J3 1,050 3,150 ACCOUNT Prepaid Rent ACCOUNT NO. 131 Jan. 1 J1 9,600 9, Adjusting J ,800 ACCOUNT Accumulated Depreciation Equipment ACCOUNT NO. 142 Jan. 31 Adjusting J Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 79

11 ACCOUNT Supplies Expense ACCOUNT NO. 517 Jan. 31 Adjusting J3 3,325 3,325 ACCOUNT Advertising Expense ACCOUNT NO. 519 Jan. 31 Adjusting J3 1,050 1,050 ACCOUNT Rent Expense ACCOUNT NO. 520 Jan. 31 Adjusting J ACCOUNT Depreciation Expense Equipment ACCOUNT NO. 523 Jan. 31 Adjusting J Analyze: If adjusting entries had not been made, net income would be overstated. 80 Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

12 Problem 5.1B ARGO COMPANY Worksheet Month Ended February 28, Adjusted Income Trial Adjustments Trial Statement Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash 73,000 73,000 73,000 Accounts Receivable 6,400 6,400 6,400 Supplies 4,200 (a) 2,000 2,200 2,200 Prepaid Rent 24,000 (b) 2,000 22,000 22,000 Equipment 46,000 46,000 46,000 Accumulated Depreciation Equip. (c) 1,000 1,000 1,000 Accounts Payable 12,000 12,000 12,000 Deloros Argo, Capital 98,500 98,500 98,500 Deloros Argo, Drawing 3,000 3,000 3,000 Fees Income 54,000 54,000 54,000 Salaries Expense 6,300 6,300 6,300 Utilities Expense 1,600 1,600 1,600 Supplies Expense (a) 2,000 2,000 2,000 Rent Expense (b) 2,000 2,000 2,000 Depreciation Expense Equip. (c) 1,000 1,000 1,000 Totals 164, ,500 5,000 5, , ,500 12,900 54, , ,500 Net Income 41,100 41,100 54,000 54, , ,600 Analyze: No depreciation has been recorded for the fiscal period, or any previous fiscal period. Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 81

13 Problem 5.2B DENISE DE LA ROSA, ATTORNEY-AT-LAW Worksheet (Partial) Month Ended November 30, Adjusted Income Trial Adjustments Trial Statement Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash 17,525 17,525 Accounts Receivable 4,250 4,250 Supplies 5,200 (a) 1,800 3,400 Prepaid Rent 22,100 (b) 1,700 20,400 Equipment 33,000 33,000 Accum. Deprec. Equip (c) Accounts Payable 8,500 8,500 Denise De La Rosa, Capital 40,000 40,000 Denise De La Rosa, Drawing 3,000 3,000 Fees Income 42,850 42,850 Salaries Expense 5,400 5,400 Utilities Expense Supplies Expense (a) 1,800 1,800 Rent Expense (b) 1,700 1,700 Deprec. Exp. Equip. (c) Totals 91,350 91,350 3,775 3,775 91,625 91,625 Analyze: Accumulated Depreciation Equipment 82 Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

14 Problem 5.3B ARROW ACCOUNTING SERVICES Income Statement Month Ended December 31, Revenue Fees Income ,330 Expenses Salaries Expense ,600 Supplies Expense Utilities Expense ,080 Rent Expense ,500 Advertising Expense Depreciation Expense Fixtures Total Expenses ,880 Net Income ,450 ARROW ACCOUNTING SERVICES Statement of Owner s Equity Month Ended December 31, John Arrow, Capital, December 1,... 30,000 Net Income for Year ,450 Less Withdrawals for Year ,000 Increase in Capital ,450 John Arrow, Capital, December 31,.. 33,450 ARROW ACCOUNTING SERVICES Sheet December 31, Assets Cash ,950 Accounts Receivable ,200 Supplies Prepaid Advertising ,200 Fixtures ,000 Less Accumulated Depreciation ,700 Total Assets ,950 Liabilities & Owner s Equity Liabilities Accounts Payable ,500 Owner s Equity John Arrow, Capital ,450 Total Liabilities & Owner s Equity ,950 Analyze: Adjusting entries decreased the assets of the company by $1,700. Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 83

15 Problem 5.4B TORRES ESTATE PLANNING AND INVESTMENTS Worksheet Month Ended June 30, Adjusted Income Trial Adjustments Trial Statement Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash 9,850 9,850 9,850 Accounts Receivable 3,050 3,050 3,050 Supplies 3,800 (a) 2,300 1,500 1,500 Prepaid Advertising 7,200 (b) 1,800 5,400 5,400 Prepaid Rent 18,000 (c) 1,500 16,500 16,500 Equipment 24,000 24,000 24,000 Accumulated Depreciation Equip. (d) Accounts Payable 5,400 5,400 5,400 Paul Torres, Capital 30,050 30,050 30,050 Paul Torres, Drawing 2,000 2,000 2,000 Fees Income 36,900 36,900 36,900 Advertising Expense (b) 1,800 1,800 1,800 Depreciation Expense Equipment (d) Rent Expense (c) 1,500 1,500 1,500 Salaries Expense 3,800 3,800 3,800 Supplies Expense (a) 2,300 2,300 2,300 Utilities Expense Totals 72,350 72,350 6,000 6,000 72,750 72,750 10,450 36,900 62,300 35,850 Net Income 26,450 26,450 36,900 36,900 62,300 62, Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

16 TORRES ESTATE PLANNING AND INVESTMENTS Income Statement Month Ended June 30, Revenue Fees Income ,900 Expenses Salaries Expense ,800 Utilities Expense Supplies Expense ,300 Advertising Expense ,800 Rent Expense ,500 Depreciation Expense Equipment Total Expenses ,450 Net Income ,450 TORRES ESTATE PLANNING AND INVESTMENTS Statement of Owner s Equity Month Ended June 30, Paul Torres, Capital, June 1, ,050 Net Income for June ,450 Less Withdrawals for June ,000 Increase in Capital ,450 Paul Torres, Capital, June 30, ,500 TORRES ESTATE PLANNING AND INVESTMENTS Sheet June 30, Assets Cash ,850 Accounts Receivable ,050 Supplies ,500 Prepaid Advertising ,400 Prepaid Rent ,500 Equipment ,000 Less Accumulated Depreciation Equipment ,600 Total Assets ,900 Liabilities & Owners Equity Liabilities Accounts Payable ,400 Owner s Equity Paul Torres, Capital ,500 Total Liabilities & Owner s Equity ,900 Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 85

17 GENERAL JOURNAL PAGE 3 Date Description Ref. Debit Credit Adjusting Entries Jun. 30 Supplies Expense ,300 Supplies , Advertising Expense ,800 Prepaid Advertising , Rent Expense ,500 Prepaid Rent , Depreciation Expense Equipment Accumulated Depreciation Equipment GENERAL LEDGER ACCOUNT Supplies ACCOUNT NO. 121 Jun. 1 J1 3,800 3, Adjusting J3 2,300 1,500 ACCOUNT Prepaid Advertising ACCOUNT NO. 130 Jun. 1 J1 7,200 7, Adjusting J3 1,800 5,400 ACCOUNT Prepaid Rent ACCOUNT NO. 131 Jun. 1 J1 18,000 18, Adjusting J3 1,500 16,500 ACCOUNT Accumulated Depreciation Equipment ACCOUNT NO. 142 Jun. 30 Adjusting J Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

18 ACCOUNT Supplies Expense ACCOUNT NO. 517 Jun. 30 Adjusting J3 2,300 2,300 ACCOUNT Advertising Expense ACCOUNT NO. 519 Jun. 30 Adjusting J3 1,800 1,800 ACCOUNT Rent Expense ACCOUNT NO. 520 Jun. 30 Adjusting J3 1,500 1,500 ACCOUNT Depreciation Expense Equipment ACCOUNT NO. 523 Jun. 30 Adjusting J Analyze: Generally accepted accounting principles require that the original cost of the asset appear in the asset account until the asset has been used up or disposed. A contra asset account is used to record depreciation costs. Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 87

19 Challenge Problem MANDELA INTERNATIONAL COMPANY Worksheet Month Ended January 31, Adjusted Income Trial Adjustments Trial Statement Sheet Account Name Debit Credit Debit Credit Debit Credit Debit Credit Debit Credit Cash 18,475 18,475 18,475 Accounts Receivable 3,400 3,400 3,400 Supplies 2,150 (a) 1,050 1,100 1,100 Prepaid Insurance 15,000 (b) 2,500 12,500 12,500 Equipment 24,000 24,000 24,000 Accumulated Depreciation Equipment (c) Accounts Payable 6,000 6,000 6,000 Wilson Mandela, Capital 40,000 40,000 40,000 Wilson Mandela, Drawing 2,000 2,000 2,000 Fees Income 30,925 30,925 30,925 Advertising Expense 1,500 1,500 1,500 Rent Expense 2,500 2,500 2,500 Salaries Expense 6,700 6,700 6,700 Supplies Expense (a) 1,050 1,050 1,050 Insurance Expense (b) 2,500 2,500 2,500 Telephone Expense Utilities Expense Depreciation Expense (c) Totals 76,925 76,925 3,750 3,750 77,125 77,125 15,650 30,925 61,475 46,200 Net Income ,925 30,925 61,475 61, Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

20 MANDELA INTERNATIONAL COMPANY Income Statement Month Ended January 31, Revenue Fees Income ,925 Expenses Advertising Expense ,500 Rent Expense ,500 Salaries Expense ,700 Supplies Expense ,050 Insurance Expense ,500 Telephone Expense Utilities Expense Depreciation Expense Total Expenses ,650 Net Income ,275 MANDELA INTERNATIONAL COMPANY Statement of Owner s Equity Month Ended January 31, Wilson Mandela, Capital, January 1,. 40,000 Net Income for January ,275 Less Withdrawals for January ,000 Increase in Capital ,275 Wilson Mandela, Capital, January 31, 53,275 MANDELA INTERNATIONAL COMPANY Sheet January 31, Assets Cash ,475 Accounts Receivable ,400 Supplies ,100 Prepaid Insurance ,500 Equipment ,000 Less Accumulated Depreciation Equipment ,800 Total Assets ,275 Liabilities and Owner s Equity Liabilities Accounts Payable ,000 Owner s Equity Wilson Mandela, Capital ,275 Total Liabilities and Owners Equity ,275 Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 89

21 GENERAL JOURNAL PAGE 3 Date Description Ref. Debit Credit Adjusting Entries Jan. 31 Supplies Expense ,050 Supplies , Insurance Expense ,500 Prepaid Insurance , Depreciation Expense Equipment Accumulated Depreciation Equipment GENERAL LEDGER ACCOUNT Supplies ACCOUNT NO. 121 Jan. 1 2,150 2, Adjusting J3 1,050 1,100 ACCOUNT Prepaid Insurance ACCOUNT NO. 131 Jan. 1 15,000 15, Adjusting J3 2,500 12,500 ACCOUNT Accumulated Depreciation Equipment ACCOUNT NO. 142 Jan. 31 Adjusting J ACCOUNT Supplies Expense ACCOUNT NO. 518 Jan. 31 Adjusting J3 1,050 1, Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

22 ACCOUNT Insurance Expense ACCOUNT NO. 519 Jan. 31 Adjusting J3 2,500 2,500 ACCOUNT Depreciation Expense-Equipment ACCOUNT NO. 524 Jan. 31 Adjusting J Analyze: If the useful life of the equipment had been 12 years instead of 10 years, depreciation would have been $167 rather than $200. Net income would have been $33 greater. Critical Thinking Problem TO: Ellis Coppell, President FROM: Student s Name DATE: Current Date SUBJECT: Effect on Financial Statements of Omitting Adjusting Entries Adjusting entries are recorded to update the accounts at the end of the accounting period for previously unrecorded items that belong to that period. If these entries are omitted, the net income will not be an accurate measure of the operation of the company for the year and certain accounts on the balance sheet will not report correct end-of-year balances. In particular, Coppell Enterprise s net income for the year will be overstated by $52,300; net income should be $112,700 instead of $165,000. This amount represents a 32% decrease in net income over the amount that would be reported if the adjusting entries were not made. ($52,300 $165,000 = 0.32). This decrease in net income results from not making adjusting entries for the following unrecorded expenses: 1. Expense of rent for the year $21,000 ($42,000 x 6/12 = $21,000 for 6 months) 2. Expense of supplies used during the year 14,500 (Total supplies of $18,000 Ending Inventory of $3,500 = $14,500 supplies used) 3. Depreciation expense for the year 16,800 ($420, = $16,800 depreciation per year) Total increase in expenses $52,300 In addition to overstating the net income, the balances of Prepaid Rent and Supplies on the Sheet would be overstated and the book value of the Building would also be overstated. Preparation of the adjusting entries would permit the financial statements to present a more accurate measure of the company s operations for the year and its financial condition at the end of the year. Therefore, it is important and the time is well spent to prepare adjusting entries so that the financial statements are up to date and present an accurate picture of the business. Copyright The McGraw-Hill Companies, Inc. All rights reserved. Chapter 5 91

23 Business Connections Managerial Focus 1. Accounting records generally reflect an asset s historical or original cost, less accumulated depreciation (not market value). 2. Depreciation Expense will offset income. Accumulated Depreciation will decrease the value of the asset. 3. Are necessary to present an accurate financial position of the firm. 4. Provides end-of-period adjusting entries and contains income statement and balance sheet accounts. Ethical Dilemma If the company wanted to donate to a nonprofit organization they would write a check and get a tax deduction. It is unethical to record higher costs than are actually incurred. Streetwise 1. Answers will vary. Accruals for interest expense, interest income, adjustments for depreciation, salaries, deferral of income taxes, and accrual of sales tax payable. 2. $1,180 million. Current year depreciation expense increases the accumulated depreciation account. Financial Statement Analysis % ($1,124 $23,978) % ($13,754 $23,978) years ($10,224 $1,124) Extending the Thought Students responses will vary. This situation extends the topic of adjusting entries to potentially uncollectible accounts. Students may believe that the customer s account receivable should be reduced to zero since the likelihood of payment is low. Other students may suggest that the account be left intact until a determination is made that the customer will not make the payment. Business Communication Answers will vary, but students notes should reflect a diplomatic introduction of the topic when phoning the owner. The accountant should recommend more frequent depreciation adjustments in order to provide upto-date records of the assets and expenses of the company. Team Work Mr. Mincks has expenses that will appear on the income statement. He needs to match these expenses with revenue. He can record the revenue as a receivable, other than accounts receivable, for the amount that he has completed. In this case he can record $15,000 or 15% of the price of the job. Internet Connection Professional liability, surety bonds, umbrella policies, errors and omissions, product liability, fire, auto, dental, workmen s compensation, sexual harassment. Practice Test Answer Key Part A True-False 1. T 2. F 3. T 4. T 5. T 6. T 7. T 8. T 9. F 10. T Part B Matching 1. a 2. e 3. f 4. c 5. b 6. d 92 Chapter 5 Copyright The McGraw-Hill Companies, Inc. All rights reserved.

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