Chapter 4, Problem 7PB

a.

To determine

Prepare the adjusting entry as at December 31, Year 1.

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.

Prepare the adjusting entries:

Date	Account titles and Explanation	Debit ($)	Credit ($)
December 31	Accounts receivable	1,500
	Studio revenue earned		1,500
	(To record the accrued studio revenue earned)
December 31	Unearned Retainer fees	2,500
	Client fees earned		2,500
	(To record  the collection of advance)
December 31	Office supplies expense $\left(\$205-\$110\right)$	95
	Office supplies		95
	(To record  the insurance expense)
December 31	Depreciation expense: Office Equipment (1)	750
	Accumulated depreciation: Office Equipment		750
	(To record the depreciation expense)
December 31	Rent expense (2)	300
	Prepaid rent		300
	(To record the rent expense)
December 31	Insurance expense (3)	90
	Unexpired insurance		90
	(To record the insurance expense)
December 31	Salaries expense	1,900
	Salaries payable		1,900
	(To record the salaries expense)
December 31	Interest expense (4)	60
	Interest payable		60
	(To record the interest expense)
December 31	Income taxes expense $\left(\$7,500-\$6,900\right)$	600
	Income taxes payable		600
	(To record the income tax expense)

Table (1)

1. To record the accrued revenue earned:

• Accounts receivable is an asset account and it is increased. Therefore, debit accounts receivable with $1,500.
• Client fees earned is a revenue account and it increases the stockholders’ equity account. Therefore, credit client fees earned with $1,500.

2. To record the collections made in advance:

• Unearned retainer fees are a liability account and it is decreased. Therefore, debit unearned retained fees with $2,500.
• Client fees earned is a revenue account and it increases the stockholders’ equity account. Therefore, credit client fees earned with $2,500.

3. To record the office supplies expense:

• Office supplies expense is an expense account and it decreases the stockholders’ equity account. Therefore, debit office supplies expense with $95.
• Office supplies are an asset account and it is decreased. Therefore, credit office supplies with $95.

4. To record the depreciation expense, Office Equipment:

• Depreciation expense is an expense account and it decreases the stockholders’ equity account. Therefore, debit depreciation expense with $750.
• Accumulated depreciation is a contra-account and it decreases the value of asset. Therefore, credit accumulated depreciation with $750.

Working note:

Calculate the amount of depreciation expense:

$\begin{array}{c}\text{Depreciation expense}=\frac{\text{Cost of the recording equipment}}{\text{Number of months depreciated}}\\ =\frac{\$54,000}{\text{72Months}}\\ =\$750\end{array}$ (1)

5. To record the rent expense:

• Rent expense is an expense account and it decreases the stockholders’ equity. Therefore, debit rent expenses with $300.
• Prepaid rent is an asset account and it is decreased. Therefore, credit prepaid rent with $300.

Working note:

Calculate the amount of rent expense:

$\begin{array}{c}\text{Rent expense}=\frac{\text{Prepaid rent}}{\text{Number of months paid}}\\ =\frac{\$1,800}{\text{6Months}\left(\text{October to March}\right)}\\ =\$300\end{array}$ (2)

6. To record the insurance expense:

• Insurance expense is an expense account and it decreases the stockholders’ equity. Therefore, debit insurance expenses with $90.
• Unexpired insurance is an asset account and it is decreased. Therefore, credit unexpired insurance with $90.

Working note:

Calculate the amount of insurance expense:

$\begin{array}{c}\text{Insurance expense}=\frac{\text{Policy amount}}{\text{Number of months }}\\ =\frac{\$1,080}{\text{12Months}}\\ =\$90\end{array}$ (3)

7. To record the salaries expense:

• Salaries expense is an expense account and it decreases the stockholders’ equity. Therefore, debit salaries expenses with $1,900.
• Salaries payable is a liability account and it is increased. Therefore, credit salaries payable with $1,900.

8. To record the interest expense:

• Interest expense is an expense account and it decreases the stockholders’ equity. Therefore, debit interest expenses with $60.
• Interest payable is a liability account and it is increased. Therefore, credit interest payable with $60.

Working note:

Calculate the amount of interest expense:

$\begin{array}{c}\text{Interest expense}=\text{Note payable amount}\times \text{Interest rate}\times \frac{\text{Number of months}}{\text{Months in a year}}\\ =\$9,000\times 8\%\times \frac{1\left(\text{December}\right)}{12}\\ =\$60\end{array}$ (4)

9. To record the income tax expense:

• Income tax expense is an expense account and it decreases the stockholders’ equity. Therefore, debit income tax expenses with $600.
• Income tax payable is a liability account and it is increased. Therefore, credit salaries payable with $600.

b.

To determine

Prepare the adjusted trial balance dated December 31, Year 1.

Explanation of Solution

Adjusted trial balance:

Adjusted trial balance is a summary of all the ledger accounts, and it contains the balances of all the accounts after the adjustment entries are journalized, and posted.

Prepare the adjusted trial balance dated December 31, Year 1:

Agency SI
Adjusted trial balance
For the year ended December 31, Year 1
Particulars	Debit ($)	Credit($)
Cash	$40,585
Accounts receivable	$3,500
Office supplies	$110
Prepaid rent	$900
Unexpired insurance	$180
Office Equipment	$54,000
Accumulated depreciation: Office equipment		$36,000
Accounts payable		$1,400
Interest payable		$420
Income taxes payable		$2,350
Note payable		$9,000
Unearned retainer fees		$1,000
Salaries payable		$1,900
Capital stock		$30,000
Retained earnings		$8,000
Dividends	$1,000
Client fees earned		$64,000
Office supplies expense	$700
Depreciation expense: Office equipment	$9,000
Rent expense	$6,075
Insurance expense	$1,100
Salaries expense	$29,000
Interest expense	$420
Income tax expense	$7,500
Totals	$154,070	$154,070

Table (2)

c.

To determine

Compute the net income for the year ended December 31, Year 1.

Explanation of Solution

Agency SI
Income Statement
For the Year Ended December 31, Year 1
Particulars	Amount ($)	Amount ($)
Revenue
Client fees earned	$64,000
Total Revenue		$64,000
Expenses:
Office supplies expense	$700
Depreciation expense: office equipment	$9,000
Rent expense	$6,075
Insurance expense	$1,100
Salaries expense	$29,000
Interest expense	$420
Income taxes expense	$7,500
Total Expenses		$53,795
Net Income		$10,205

Table (3)

Thus, the net income for the year ended December 31, Year 1 is $10,205.

d.

To determine

Identify the company’s average monthly rent expense in January through September for Year 1.

Explanation of Solution

Calculate the average monthly rent expense from January through September for Year 1.

Particulars	Amount ($)
Rent expense for 12 months ended December 31, Year 1	$6,075
Less: Rent expense in October through December  $\left(\$300\times \text{3months}\right)$	$900
Rent expense for January through September	$5,175
Average monthly rent expense for January to September  $\left(\frac{\$5,175}{9\text{months}}\right)$	$575

Table (4)

Thus the average monthly rent expense from January through September is $575 for year 1.

e.

To determine

Identify the average company’s monthly insurance expense in January and February of Year 1.

Explanation of Solution

Calculate the average monthly insurance expense for January to July:

Particulars	Amount ($)
Insurance expense for 12 months ended	$1,100
Less: Insurance expense from March through December $\left(\$90\times \text{10months}\right)$	$900
Insurance expense for January through February	$200
Average monthly insurance expense for January to February $\left(\frac{\$200}{\text{2Months}}\right)$	$100

Table (5)

Thus, the average monthly insurance expense from January through February is $100 for Year 1.

e.

To determine

Determine the life of the office equipment from the beginning of company’s operation.

Explanation of Solution

Determine the life of the office equipment from the beginning of company’s operation.

Particulars	Amount ($)
Accumulated depreciation per trial balance	$35,250
Add: December depreciation expense (adjusting entry 4)	$750
Accumulated depreciation at December 31, Year 1	$36,000
Age of equipment at December 31, Year 1$\left(\frac{\$36,000}{\$750\text{Per month}}\right)$	48 months

Table (6)

Thus, the age of the equipment is 48months or 4 years.

f.

To determine

Indicate the effect of the adjusting entry on the income statement and balance sheet.

Explanation of Solution

Indicate the effect of the adjusting entry on the income statement and balance sheet.

Table (7)

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Balance sheet: This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Note:

“I” represents Increase

“D” represents Decrease

“NE” represents No effect