Chapter 3, Problem 3P

To determine

Prepare necessary adjusting entries of Company S for the year ended December 31, 2016, and show the necessary calculation.

Explanation of Solution

Adjusting entries: Adjusting entries are those entries which are recorded at the end of the year, to update the income statement accounts (revenue and expenses) and balance sheet accounts (assets, liabilities, and stockholders’ equity) to maintain the records according to accrual basis principle.

1. Prepare an adjusting entry to record the interest revenue earned at the end of the year.

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2016	Interest receivable	500
	Interest revenue (1)		500
	(To record the interest revenue earned at the end of the accounting year)

Table (1)

• Interest receivable is an asset account, and it increases the value of asset. Hence, debit the interest receivable account with $500.
• Interest revenue is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the interest revenue with $500.

Working note (1):

Calculate the value of interest revenue.

$\begin{array}{c}\text{Interest revenue}=\left[\begin{array}{l}\text{Note receivable}\times \text{Interest rate}\times \\ \left(\frac{\text{Number of months interest occrued}}{\text{Months in a year}}\right)\end{array}\right]\\ =\$10,000\times \frac{10}{100}\times \frac{6}{12}\left(\text{July 2 to December 31}\right)\\ =\$500\end{array}$

2. Prepare the adjusting entry for the overstated insurance expense.

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2016	Prepaid insurance (2)	2,375
	Insurance expense		2,375
	(To adjust the overstated insurance expense at the end of the accounting year)

Table (2)

• Prepaid insurance is an asset account, and it increases the value of assets. Hence, debit the prepaid insurance account with $2,375.
• Insurance expense is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the insurance expense with $2,375.

Working note (2):

Calculate the value of overstated insurance expense.

$\begin{array}{c}\text{Overstated insurance expense = }\left(\begin{array}{l}\text{Value of policy }\times \\ \left[\frac{\text{Number of months left }}{\text{Number of months policy covered}}\right]\end{array}\right)\\ =\$3,000\times \frac{19\text{ months }}{24\text{ months}}\\ =\$2,375\end{array}$

Note: Number of months left in insurance policy is 19 months $\left(\text{24 months }-5\text{ months}\right)$, as 5 months (August 1 to December 31) is covered during the current year.

3. Prepare an adjusting entry to record the depreciation expense incurred at the end of the year.

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2016	Depreciation expense	2,080
	Accumulated depreciation-Building (3)		2,080
	(To record the depreciation expense incurred at the end of the accounting year)

Table (3)

• Depreciation expense is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the depreciation expense with $2,080.
• Accumulated depreciation is a contra-asset account, and it decreases the value of assets. Hence, credit the accumulated depreciation expense with $2,080.

Working note (3):

Calculate the depreciation expense on building.

$\begin{array}{c}\begin{array}{l}\text{Depreciation }\\ \text{expense on building}\end{array}\}\text{ = }\frac{\text{Cost of building}-\text{Residual value}}{\text{Useful life of the assets}}\\ =\frac{\$60,000-\$8,000}{25\text{ years}}\\ =\$2,080\end{array}$

4. Prepare an adjusting entry to record the depreciation expense incurred at the end of the year.

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2016	Depreciation expense	900
	Accumulated depreciation-Delivery equipment (4)		900
	(To record the depreciation expense incurred at the end of the accounting year)

Table (4)

• Depreciation expense is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the depreciation expense with $900.
• Accumulated depreciation is a contra-asset account, and it decreases the value of assets. Hence, credit the accumulated depreciation expense with $900.

Working note (4):

Calculate the depreciation expense on equipment at the end of the year.

$\begin{array}{c}\text{Depreciation expense = }\left[\begin{array}{l}\left(\frac{\text{Cost of assets}-\text{Residual value}}{\text{Useful life of the assets}}\right)\times \\ \left(\frac{\text{Number of months depreciation occrued}}{\text{Number of months in a year}}\right)\end{array}\right]\\ =\frac{\$14,000-\$2,000}{\text{10 years}}\times \frac{9\text{ (April 2 to December 31)}}{12}\\ =\$900\end{array}$

5. Prepare an adjusting entry to record the rent revenue recognized at the end of the year.

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2016	Unearned rent	720
	Rent revenue (5)		720
	(To record the rent revenue recognized at the end of the accounting year)

Table (5)

• Unearned rent is a liability account, and it decreases the value of liability. Hence, debit the unearned rent account with $720.
• Rent revenue is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the rent revenue with $720.

Working note (5):

Calculate the value of rent revenue.

$\begin{array}{c}\text{Rent revenue = }\left[\begin{array}{l}\text{Value of note }\times \\ \left(\frac{\text{Number of months rent revenue earned}}{\text{Number of months in 2 years }}\right)\end{array}\right]\\ =\$4,320\times \frac{\text{4 months (September1 to December 31)}}{\text{24 months}}\\ =\$720\end{array}$

6. Prepare an adjusting entry to record the insurance expense occurred at the end of the year.

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2016	Interest expense (6)	72
	Interest payable		72
	(To record the interest expense accrued at the end of the accounting year)

Table (6)

• Interest expense is component of shareholders’ equity, and it decreases the value of shareholders equity. Hence, debit the interest expense with $72.
• Interest payable is a liability account and it increases in the value of liabilities. Hence, credit the interest payable with $72.

Working note (6):

Calculate the amount of interest expense.

$\begin{array}{c}\text{Interest expense}=\left[\begin{array}{l}\text{Note payable}\times \text{Interest rate}\times \\ \left(\frac{\text{Number of months interest occrued}}{\text{Months in a year}}\right)\end{array}\right]\\ =\$7,200\times \frac{12}{100}\times \frac{1}{12}\left(\text{December 1 to December 31}\right)\\ =\$72\end{array}$

7. Prepare an adjusting entry to record the office supplies unused (supplies on hand) at the end of the year.

Date	Account Title and Explanation	Debit ($)	Credit ($)
December 31, 2016	Office supplies	400
	Office supplies expense		400
	(To adjust the unused supplies at the end of the accounting year)

Table (7)

• Office supplies are asset account, and it increases the value of assets. Hence, debit the office supplies account with $400.
• Offices supplies expense is component of shareholders’ equity, and it increases the value of shareholders equity. Hence, credit the office supplies expense with $400.