Chapter 2, Problem 33P

Problem 2-37A Effect of adjusting entries on the accounting equation

CHECK FIGURES

d. Adjustment amount: $4,000

Required

Each of the following independent events requires a year-end adjusting entry. Show how each event and its related adjusting entry affect the accounting equation. Assume a December 31 closing date. The first event is shown as an example.

1. a. Paid $4,800 cash in advance on October 1 for a one-year insurance policy.
2. b. Received a $3,600 cash advance for a contract to provide services in the future. The contract required a one-year commitment, starting April 1.
3. c. Purchased $1,200 of supplies on account. At year’s end, $175 of supplies remained on hand.
4. d. Paid $9,600 cash in advance on August 1 for a one-year lease on office space.

To determine

Show the manner in which the events and its related adjusting entries would affect the accounting equation.

Answer to Problem 33P

Prepare a table exhibiting the events and the adjusting entries that would affect the accounting equation are as follows:

Company
Accounting equation
Event / Adjustment	Total Assets			=	Liabilities	+	Stockholder's Equity
	Cash		Other assets				Common Stock	Retained Earnings
a. (Given)	($4,800)	+	$4,800	=	NA	+	NA	NA
Adjustment (1)	NA	+	($1,200)	=	NA	+	NA	($1,200)
b.	$3,600	+	NA	=	$3,600	+	NA	NA
Adjustment (2)	NA	+	NA	=	($2,700)	+	NA	$2,700
c.	NA	+	$1,200	=	$1,200	+	NA	NA
Adjustment (3)	NA	+	($1,025)	=	NA	+	NA	($1,025)
d.	($9,600)	+	$9,600	=	NA	+	NA	NA
Adjustment (4)	NA	+	($4,000)	=	NA	+	NA	($4,000)

Table (1)

Explanation of Solution

Accounting equation: Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below.

$\text{Assets}=\text{ Liabilities}+\text{Stockholders' equity}$

The effects of the events and adjustments can be explained as follows:

a. Paid $4,800 cash in advance on October 1 for a one-year insurance policy.

The cash account (asset) is decreased by $4,800 and the prepaid insurance (asset) account is increased by $4,800. When the insurance expense is recognized for 3 months at the end of the year, the prepaid insurance (asset) account is decreased by $1,200 (1) and amount of insurance expense (expense account) is increased by $1,200. Increase in insurance expense account decreases the retained earnings by the same amount.

b. Received a $3,600 cash advance for a contract to provide services in the future. The contract required a one-year commitment, starting April 1.

The cash account (asset) is increased by $3,600 and the unearned revenue account (liability) is increased by $3,600. The revenue would be recognized when the services are provided to the client. After providing the service for 9 months from April 1 to December 31, revenue should be recognized for 9 months at the end of the year. While recognizing the earned unearned revenue, the unearned revenue (liability) is decreased by $2,700 (2) and the revenue account is increased by $2,700. Increase in revenue account increases the retained earnings by the same amount.

c. Purchased $1,200 of supplies on account. At year’s end, $175 of supplies remained on hand.

The supplies account (asset) is increased by $1,200 and the accounts payable (liability) account is increased by $1,200. When the supplies expenses are recognized, the supplies account (asset) is decreased by $1,025 (3) and the expense account is increased by $1,025. Increase in the expense account decreases the retained earnings by the same amount.

d. Paid $9,600 cash in advance on August 1 for a one-year lease on office space.

The cash account (asset) is decreased by $9,600 and the prepaid rent (asset) account is increased by $9,600. When the rent expense is recognized at the end of the year for 3 months, the prepaid rent (asset) account is decreased by $4,000 (4) and amount of insurance expense (expense account) is increased by $4,000. Increase in insurance expense account decreases the retained earnings by the same amount.

Working Note:

Determine the amount of prepaid insurance recognized at the end of year.

$\begin{array}{c}\text{Prepaid insurance}=\text{ Insurance expense}\times \frac{\text{Number of months expired}}{\text{Months in a year}}\\ =\$4,800\times \frac{3}{12}\\ =\$1,200\end{array}$ (1)

Determine the amount of revenue recognized at the end of year.

$\begin{array}{c}\text{Unearned revenue}=\text{ Revenue income}\times \frac{\text{Number of months revenue earned}}{\text{Months in a year}}\\ =\$3,600\times \frac{9}{12}\\ =\$2,700\end{array}$ (2)

Determine the amount of supplies used at the end of year.

$\begin{array}{c}\text{Supplies used}=\left(\begin{array}{l}\text{Supplies purchased}\\ \text{ during the year}\end{array}\right)-\left(\begin{array}{l}\text{Supplies at the }\\ \text{end of year}\end{array}\right)\\ =\$1,200-\$175\\ =\$1,075\end{array}$ (3)

Determine the amount of prepaid rent recognized at the end of year.

$\begin{array}{c}\text{Prepaid rent}=\text{ Rent expense}\times \frac{\text{Months used}}{\text{Months in a year}}\\ =\$9,600\times \frac{5}{12}\\ =\$4,000\end{array}$ (4)