Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-1
CHAPTER 4
ADJUSTMENTS, FINANCIAL STATEMENTS,
AND THE QUALITY OF EARNINGS
Learning Objectives and Related Assignment Materials
Learning Objectives
Mini-
Exercises
Exercises
Problems
Alternate
Problems
Compre-
hensive
Problem
Cases and
Projects
1. Explain the purpose of
adjustments and analyze
the adjustments necessary
at the end of the period to
update balance sheet and
income statements
accounts.
1, 2, 3, 4,
5, 6, 7
1, 2, 3, 4,
5, 6, 7, 8,
9, 10, 11,
12, 13,
14, 15,
16, 17,
18, 19
1, 2, 3, 4,
5, 6, 7
1, 2, 3, 4,
5, 6, 7
1, 2
4, 5, 6, 7,
8, 9, 10
2. Present an income
statement with earnings per
share, statement of
stockholders’ equity, and
balance sheet.
8, 9, 10,
12
4, 11, 15,
16, 17,
19
7
6,7
1, 2
1, 2, 3, 4,
6, 7, 8,
10
3. Compute and interpret the
total asset turnover ratio.
11
17
6
6
1, 2
1, 2, 3, 8,
10
4. Explain the closing
process.
12
2, 10, 20
6, 7
6, 7
1, 2
1, 2, 5
Synopsis of Chapter Revisions
Focus Company: Chipotle Mexican Grill
▪ New focus company Chipotle Mexican Grill
▪ The March 31, 2012, statements in Chapter 4 are quite similar to the actual quarterly statements of
Chipotle, except for a few simplifications.
▪ The key ratio in this chapter was changed from Net Profit Margin ratio to the Total Asset Turnover
ratio.
▪ New GUIDED HELP feature provides free access to step-by-step video instruction on recording
adjusting entries.
▪ New CONTINUING CASE added where students prepare adjusting entries for Penny’s Pool Service.
▪ New and updated real companies, as well as modified accounts, names, and amounts for fictional
companies in end-of-chapter exercises, problems, and cases with requirements reflecting the changes
in topics emphasized in each chapter.
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
PowerPoint Slides
Learning Objectives
PowerPoint® Slides
1. Explain the purpose of adjustments and analyze the adjustments necessary
at the end of the period to update balance sheet and income statements
accounts.
4-1 through 4-41
2. Present an income statement with earnings per share, statement of
stockholders’ equity, and balance sheet.
4-42 through 4-49
3. Compute and interpret the total asset turnover ratio.
4-50
4. Explain the closing process.
4-51 through 4-54
Related Video Programs
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-3
Chapter Take-Aways
1. Explain and purpose of adjustments and analyze the adjustments necessary at the end of the
period to update balance sheet and income statements accounts.
Adjusting entries are necessary at the end of the accounting period to measure income properly,
correct errors, and provide for adequate valuation of balance sheet accounts. There are four types:
• Unearned revenues – previously recorded liabilities created when cash was received in advance
that must be adjusted for the amount of revenue earned during the period.
• Accrued revenues – revenues that were earned during the period but were not yet recorded (cash
will be received in the future).
• Prepaid expenses – previously recorded assets (Prepaid Rent, Supplies, and Equipment) that must
be adjusted for the amount of expense incurred during the period.
• Accrued expenses – expense that were incurred during the period but were not yet recorded (cash
will be paid in the future).
The analysis involves:
Step 1: Determining if revenue was earned or an expense incurred. Record an increase in the revenue
or expense account.
Step 2: Determining whether cash was received or paid in the past or will be received or paid in the
future. If in the past, the existing asset or liability is overstated and needs to be reduced. If in
the future, the related receivable or payable account needs to be increased.
Step 3: Computing the amount of revenue earned or expense incurred in the period.
• Recording adjusting entries has no effect on the Cash account.
2. Present an income statement with earnings per share, statement of stockholders’ equity, and
balance sheet.
Adjusted account balances are used in preparing the following financial statements:
• Income Statement: Revenues – Expenses = Net Income (including earnings per share computed
as net income divided by the average number of shares of common stock outstanding during the
period).
• Statement of Stockholders’ Equity: (Beginning Contributed Capital + Stock Issuances – Stock
Repurchases) + (Beginning Retained Earnings + Net Income – Dividends Declared) = Ending
Total Stockholders’ Equity.
• Balance Sheet: Assets = Liabilities + Stockholders’ Equity.
3. Compute and interpret the total asset turnover ratio.
The total asset turnover ratio (Sales Average Total Assets) measures sales generated per dollar of
assets used. A rising total asset turnover signals more efficient management of assets.
4. Explain the closing process.
Temporary accounts (revenues, expenses, gains, and losses) are closed to a zero balance at the end of
the accounting period to allow for the accumulation of income items in the following period. To close
these accounts, debit each revenue and gain account, credit each expense and loss account, and record
the difference (equal to net income) to Retained Earnings.
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-4
Key Ratio
Total asset turnover measures sales generated per dollar of assets. A high or rising ratio suggests that the
company is managing its assets more efficiently. It is computed as follows:
Total Asset Turnover = Sales (or Operating) Revenues Average Total Assets
Finding Financial Information
BALANCE SHEET
INCOME STATEMENT
Current Assets
Accrued revenues
include:
Interest receivable
Rent receivable
Deferred expenses
include:
Supplies
Prepaid insurance
Noncurrent Assets
Deferred expenses
include:
Property and
equipment
Intangibles
Current Liabilities
Accrued expenses
include:
Interest payable
Wages payable
Utilities payable
Income tax
payable
Deferred revenues
include:
Unearned revenue
Revenues
Increased by adjusting entries
Expenses
Increased by adjusting entries
Pretax Income
Income tax expense
Net Income
STATEMENT OF CASH FLOWS
NOTES
Adjusting Entries Do Not Affect Cash
In Various Notes
(if not on the balance sheet)
Details of accrued expenses payable
Interest paid and income taxes paid
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-5
Chapter Outline
Teaching Notes
LO 1 – Explain the purpose of adjustments and analyze the adjustments necessary at the end of the
period to update balance sheet and income statements accounts.
I. Adjusting Revenues and Expenses
A. Accounting Cycle – process followed by entities to analyze
and record transactions, adjust the records at the end of the
period, prepare financial statements, and prepare the records
for the next cycle
Illustrated in Exhibit 4.1
1. During the accounting period, transactions that result in
exchanges are analyzed and recorded in the general
journal in chronological order (journal entries), and the
related accounts are updated in the general ledger
2. At the end of the accounting period, adjustments record
revenues and expenses in the proper period and update
the balance sheet accounts for reporting purposes
B. Purposes of Adjustments
Show Video Program #4
1. Accounting systems are designed to record most recurring
daily transactions
2. As cash is received or paid, it is recorded
3. Cash is not always received in the period in which the
company earns revenue or paid in the period in which the
company incurs an expense
4. Solution to the problem created by differences in timing
is to record adjusting entries at the end of every
accounting period, so that:
a. Revenues are recorded when they are earned (the
revenue realization principle)
b. Expenses are recorded when they are incurred to
generate revenue (the expense matching principle)
c. Assets are reported at amounts that represent the
probable future benefits remaining at the end of the
period, and
d. Liabilities are reported at amounts that represent the
probable future sacrifices of assets or services owed at
the end of the period
4. Companies wait until the end of the accounting period to
adjust their accounts; adjusting daily would be very costly
and time-consuming
5. Adjusting entries are required every time a company
wants to prepare financial statements for external users
C. Types of Adjustments – each of the four types of adjustments
involves two entries:
1. One for the cash receipt or payment
2. One for recording the revenue or expense in the proper
period through the adjusting entry
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-6
D. Adjustment Process
Use Supplemental
Enrichment Activity #1
1. In analyzing adjustments at the end of the period, there
are three steps:
a. Step 1: Ask: Was revenue earned or an expense
incurred that is not yet recorded?
Use Supplemental
Enrichment Activity #2
i. If the answer is YES, credit the revenue account or
debit the expense account in the adjusting journal
entry (or AJE)
ii. If the answer is NO, no adjustment is required
b. Step 2: Ask: Was the related cash received or paid in
the past or will it be received or paid in the future?
Illustrated in Exhibit 4.2
i. If cash was received in the past (creating a
deferred revenue [liability] account in the past) →
Reduce the liability account that was recorded
when cash was received because some or all of the
liability has been earned since then
ii. If cash will be received in the future → Increase
the receivable account to record what is owed by
others to the company (creates an accrued revenue)
iii. If cash was paid in the past (creating a deferred
expense account [asset] in the past) → Reduce the
asset account that was recorded in the past because
some or the entire asset has been used since then
iv. If cash will be paid in the future → Increase the
payable account to record what is owed by the
company to others (creates an accrued expense).
c. Cash is never included in the adjusting entry, because
it was recorded already in the past or will be recorded
in the future.
d. Step 3: Compute the amount of revenue earned or
expense incurred. Sometimes the amount:
i. Is given or known
ii. Must be computed
iii. Must be estimated
2. Deferred Revenues
a. When a customer pays for goods or services before the
company delivers them, the company records the
amount of cash received in a deferred (or unearned)
revenue account
b. Deferred (or unearned) revenue account is a liability
representing the company’s promise to perform or
deliver the goods or services in the future
c. Recognition of (recording) the revenue is postponed
(deferred) until the company meets its obligation
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-7
d. AJE 1 – Chipotle received cash last period from
customers purchasing gift cards and recorded an
increase in Cash and an increase in Unearned
Revenues, a liability, to recognize the business’s
obligation to provide future services to customers.
During the first quarter of 2012, customers redeemed
the gift cards for $21,300 in food service.
dr Unearned Revenue (–L)
21,300
cr Restaurant Sales Revenue
(+R, +SE)
21,300
Assets = Liabilities + Stockholders’ Equity
0 = Unearned Revenue (L) – 21,300 + Restaurant
Sales Revenue (R) + 21,300
3. Accrued Revenues
a. AJE 2 – Investments owned by Chipotle earned $200
in additional investment income for the quarter, but
the cash has not yet been received
dr Interest Receivable (+A)
200
cr Investment Income (+R, +SE)
200
Assets = Liabilities + Stockholders’ Equity
Interest Receivable (A) + 200= Investment Income (R)
+ 200
3. Deferred Expenses
a. Assets represent resources with probable future
benefits to the company
b. Many assets are used over time to generate revenues;
these assets are deferred expenses
c. At the end of every period, an adjustment must be
made to record the amount of the asset that was used
during the period
d. AJE 3 – Supplies include food, beverage, and paper
products for Chipotle. At the end of the quarter,
Chipotle counted $10,000 in supplies on hand, but the
Supplies account indicated a balance of $216,600
(from the unadjusted trial balance.
Beginning balance of supplies + Supply purchases
during period of $216,600 – Ending amount of
supplies on hand of 10,000 = Supplies used of
$206,600
dr Supplies Expense (+E, –SE)
206,600
cr Supplies (–A)
206,600
Assets = Liabilities + Stockholders’ Equity
Supplies (A) – 206,600 = Supplies Expense (E) –
206,600
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-8
e. AJE 4 – The Prepaid Expenses account includes:
• $36,000 paid at the beginning of the quarter for
rental of facilities at $6,000 per month (rent used =
$36,000 x 3 months in quarter ÷ 6 months prepaid).
• $32,000 for insurance coverage for one year
beginning January 2012 (insurance used = $32,000
prepaid x 3 months in quarter ÷ 12 months
coverage).
• $20,000 for advertising paid at the beginning of the
quarter for advertisements to be placed during the
quarter (advertising all used during the quarter).
Amount of expense incurred:
• Rent used = $36,000 x 3 months in quarter ÷ 6
months prepaid = $18,000
• Insurance used = $32,000 prepaid x 3 months in
quarter ÷ 12 months coverage = $8,000
• Advertising all used during the quarter = $20,000
$18,000 + $78,000 + $20,000 = $46,000
dr Occupancy Expense (+E, –SE)
46,000
cr Prepaid Expenses ( A)
46,000
Assets = Liabilities + Stockholders’ Equity
Prepaid Expense (A) – 46,000 = Occupancy Expense
(E) – 46,000
f. Accumulated Depreciation and Depreciation Expense
i. Buildings and equipment – represent deferred
expenses that will be used over many years; thus, a
part of their cost should be expensed in the same
period (the matching principle)
ii. Depreciation is an allocation of an asset’s cost over
its estimated useful life to the company
iii. To keep track of the asset’s historical cost, the
amount that has been used is accumulated in a
contra-account – an account that is directly linked
to another account, but with an opposite balance
• Contra account is designated with an X in
front of the type of account to which it is
related
• Since assets have debit balances, Accumulated
Depreciation has a credit balance
• On the balance sheet, the amount that is
reported for Property and Equipment is its net
book value
• Net book value = ending balance in the
Property and Equipment account –ending
balance in the Accumulated Depreciation
account
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-9
g. AJE 5 – Chipotle estimates depreciation to be $80,400
per year (or $20,100 per quarter).
dr Depreciation Expense
(+E, –SE)
20,100
cr Accumulated Depreciation
(+XA, –A)
20,100
Assets = Liabilities + Stockholders’ Equity
Accumulated Depreciation (XA) – 20,100 =
Depreciation Expense (E) – 20,100
4. Accrued Expenses
a. Numerous expenses are incurred in the current period
without being paid for until the next period
b. These accrued expenses accumulate (accrue) over time
but are not recognized until the end of the period in an
adjusting entry
c. AJE 6 – Chipotle’s employees earned $13,400 in
salaries and wages for working two days at the end of
the quarter. They will be paid in the next quarter.
dr Salaries and Wages Expense
(+E, –SE)
13,400
cr Accrued Expenses Payable
(+L)
13,400
Assets = Liabilities + Stockholders’ Equity
0 = Accrued Expenses Payable (L) + 13,400 + Salaries
and Wages Expense (E) – 13,400
d. AJE 7 – Chipotle owed $233,200 in notes payable
during the quarter. The average interest rate on
Chipotle’s borrowings is 7.7%. Notes Payable (the
principal) was recorded properly when the money was
borrowed. Its balance does not need to be adjusted.
However, interest expense is incurred by Chipotle
over time as the money is used.
Amount of expense incurred:
$233,200 x .077 x 3 months ÷ 12 months = $4,500
dr Interest Expense (+E, –SE)
4,500
cr Accrued Expenses Payable
(+L)
4,500
Assets = Liabilities + Stockholders’ Equity
0 = Accrued Expenses Payable (L) + 4,500 + Interest
Expense (E) – 4,500
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-10
e. AJE 8 –Chipotle received a utility bill for $4,400 for
usage during the quarter. The bill will be paid next
quarter.
dr Occupancy Expense (+E, –SE)
4,400
cr Accrued Expenses Payable
(+L)
4,400
Assets = Liabilities + Stockholders’ Equity
0 = Accrued Expenses Payable (L) + 4,400 +
Occupancy Expense (E) – 4,400
f. AJE 9 – Income taxes of that will be paid in the next
quarter must be accrued (adjusted pretax income x
income tax rate); Chipotle’s Pretax Income =
$102,700; tax @ 38.9% = $40,000.
dr Income Tax Expense (+E, –SE)
40,000
cr Accrued Expenses Payable
(+L)
40,000
Assets = Liabilities + Stockholders’ Equity
0 = Accrued Expenses Payable (L) + 40,000 + Income
Tax Expense (E) – 40,000
Refer students to Pause for
Feedback – Self-Study Quiz
5. Note that the Cash account was never adjusted. The cash
has already been received or paid by the end of the period
or will be received or paid in the next period.
See A Question of Ethics
feature “Adjustments and
Incentives”
6. In addition, each adjusting entry always included one
income statement account and one balance sheet account.
LO 2 – Present an income statement with earnings per share, statement of stockholders’ equity, and
balance sheet.
II. Preparing Financial Statements
A. Interconnections
1. Revenues minus expenses = net income on the Income
Statement
2 Net income (or net loss) and dividends to stockholders
affect Retained Earnings and any additional issuances of
stock during the period affect the balance in Contributed
Capital, both on the Statement of Stockholders’ Equity
3. Stockholders’ Equity is a component of the Balance Sheet
B. Income Statement
1. Earnings (EPS) ratio is reported on the income statement;
it is the only ratio required to be disclosed on the
statement or in the notes to the statements
Actual computation of the
ratio is quite complex and
appropriate for more
advanced accounting courses
2. EPS = Net income ÷ Average Number of Shares of
Common Stock Outstanding during the Period
C. Statement of Stockholders’ Equity
1. The final total from the income statement, net income, is
carried forward to the Retained Earnings column of the
statement of stockholders’ equity
2. Dividends declared and an additional stock issuance are
also included in the statement
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-11
D. Balance Sheet
Use Supplemental
Enrichment Activity #3
1. The ending balances for Contributed Capital and Retained
Earnings from the statement of stockholders’ equity are
included on the balance sheet that follows.
2. The contra-asset account, Accumulated Depreciation, is
subtracted from the Property and Equipment account to
reflect net book value (or carrying value) at month-end
for balance sheet purposes
3. Assets are listed in order of liquidity, and liabilities are
listed in order of due dates
a. Current assets are those used or turned into cash
within one year (as well as inventory)
See Focus on Cash Flows
feature “Cash Flows from
Operations, Net Income, and
the Quality of Earnings”
b. Current liabilities are obligations to be paid with
current assets within one year.
LO 3 – Compute and interpret the total asset turnover ratio.
B. Total Asset Turnover Ratio
1. Total Asset Turnover Ratio = Sales (or Operating)
Revenues ÷ Average Total Assets
Use Supplemental
Enrichment Activity #4
2. Average Total Assets = (Beginning Total Assets +
Ending Total Assets) ÷ 2
3. Ratio measures how effective management is in
generating sales from assets (resources)
4. A high asset turnover ratio signifies efficient management
of assets; a low asset turnover ratio signifies less efficient
management
5. Creditors and security analysts use this ratio to assess a
company’s effectiveness at controlling both current and
noncurrent assets
6. In a well-run business, creditors expect the ratio to
fluctuate due to seasonal upswings and downturns
a. As inventory is built up prior to a heavy sales season,
companies need to borrow funds; the asset turnover
ratio declines with this increase in assets
b. Eventually, the season’s high sales provide the cash
needed to repay the loans; the asset turnover ratio then
rises with the increased sales
7. While the total asset turnover ratio may decrease due to
seasonal fluctuations, a declining ratio may also be
caused by changes in corporate policies leading to a rising
level of assets
a. Examples include relaxing credit policies for new
customers or reducing collection efforts in accounts
receivable
b. A detailed analysis of the changes in the key
components of assets is needed to determine the
causes of a change in the asset turnover ratio
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-12
LO 4 – Explain the closing process.
III. Closing the Books
Show Video Program #5
A. End of the Accounting Cycle
1. Asset, liability, and stockholders’ equity accounts
a. The ending balance in each of these accounts becomes
the beginning account balance for the next period
b. These accounts are called permanent (real) accounts
c. These accounts are not reduced to a zero balance at the
end of the accounting period
2. Revenue, expense, gain, and loss accounts
a. These accounts are used to accumulate data for the
current accounting period only
b. They are called temporary (nominal) accounts
3. Closing the books – the final step in the accounting cycle
a. The closing entry has two purposes:
i. To transfer the balances in the temporary accounts
(income statement accounts) to Retained Earnings
ii. To establish a zero balance in each of the
temporary accounts to start the accumulation in the
next accounting period
b. The closing entry is dated the last day of the
accounting period, entered in the journal, and posted
to the ledger (or T-accounts)
i. Temporary accounts with debit balances are
credited and temporary accounts with credit
balances are debited
ii. The net amount, equal to net income, affects
Retained Earnings
Refer students to Pause for
Feedback – Self-Study Quiz
B. Post-Closing Trial Balance
1. After the closing process is complete, all income
statement accounts have a zero balance; these accounts
are then ready for recording revenues and expenses in the
new accounting period
Use Supplemental
Enrichment Activity #5
2. The ending balance in Retained Earnings now is up-to–
date (matches the amount on the balance sheet) and is
carried forward as the beginning balance for the next
period
3. As the last step of the accounting cycle, a post-closing
trial balance is prepared to check that:
a. Debits still equal credits
b. All temporary accounts have been closed
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-13
Supplemental Enrichment Activities
Note: These activities would be suitable for individual or group activities.
1. Handout 4-1
Use Handout 4-1 for an in-class activity designed to review transaction analysis (preparation of
adjusting entries and impact on the accounting equation) and the posting to T-accounts. Remind
students that some companies use the account, Prepaid Expenses, to keep track of insurance
premiums that have been paid in advance, while others may instead the account, Prepaid Insurance
(or even Prepaid Insurance Expense). As indicated in the T-accounts at the end of the handout, this
handout assumes that the company uses the accounts, Prepaid Insurance and Prepaid Rent. The
solution follows the handout master.
2. Handout 4-2
If you used Handout 4-1, use Handout 4-2 for an in-class activity designed to review the preparation
of an adjusted trial balance. The solution follows the handout master.
3. Handout 4-3
If you used Handout 4-2, use Handout 4-3 for an in-class activity designed to review the preparation
of a classified balance sheet and a classified income statement. The solution follows the handout
master.
4. Handout 4-4
If you used Handout 4-3, use Handout 4-4 for an in-class activity designed to review the calculation
and interpretation of the total asset turnover ratio. The solution follows the handout master.
5. Handout 4-5
If you used Handout 4-3, use Handout 4-5 for an in-class activity designed to review the preparation
of closing entries and a post-close trial balance. The solution follows the handout master.
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-14
HANDOUT 4 – 1
ADJUSTING ENTRIES AND
POSTING TO T-ACCOUNTS
Prepare the required adjusting journal entry for each situation as of December 31, 2014. See the last page
for the unadjusted account balances shown in T-accounts.
(a) Suppose Deana’s had received a $1,800 shipment of supplies in September 2014. When counting the
supplies on December 31, 2014, Deana’s found only $800 worth of supplies on hand.
Debit and credit the accounts affected.
Dec. 31
2014
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
(b) Suppose Deana’s had paid $12,000 for six months’ rent on November 1, 2014. As of December, 31,
2014, two months’ (November & December) prepaid rent has expired.
Debit and credit the accounts affected.
Dec. 31
2014
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
(c) Suppose Deana’s had paid $6,000 for one year’s insurance on June 1, 2014.
Debit and credit the accounts affected.
Dec. 31
2014
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-15
HANDOUT 4 – 1, continued
(d) The company had acquired Property, Plant & Equipment costing $40,000 on January 1, 2014.
Suppose that the depreciation on this Equipment was calculated to be $2,000 for 2014.
Debit and credit the accounts affected.
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
(e) On December 1, 2014, the company had sold $500 in gift certificates for decorating services to a
customer. On December 31, 2014, the accountant received an envelope containing $400 worth of
redeemed gift certificates, not yet recorded in the company’s books.
Debit and credit the accounts affected.
Dec. 31
2014
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
(f) On June 30, 2014, the company invested $20,000 in a certificate of deposit that will yield 12% interest
at the end of one year.
Debit and credit the accounts affected.
Dec. 31
2014
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-16
HANDOUT 4 – 1, continued
(g) The company borrowed a note payable from the bank for $30,000 on January 1, 2014, due with all
interest on June 30, 2015. The note payable requires 10% interest.
Debit and credit the accounts affected.
Dec. 31
2014
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
(h) The company calculated its income taxes as $26,110 for the year ended December 31, 2014.
Debit and credit the accounts affected.
Dec. 31
2014
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
(i) On December 15, 2014, the company declared a $750 dividend, payable January 15, 2015.
Debit and credit the accounts affected.
Dec. 31
2014
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
Post the adjusting entries above to the T-accounts on the following page.
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-17
HANDOUT 4 – 1, continued
Assets
Liabilities
Stockholders’ Equity, continued
+ Cash –
Unadj.
43,450
+ Supplies –
Unadj.
1,800
+ Accounts Receivable –
Unadj.
4,000
+ Prepaid Rent –
Unadj.
12,000
+ Prepaid Insurance –
Unadj.
6,000
+ Certificate of Deposit –
Unadj.
20,000
+ Interest Receivable –
Unadj.
0
+ Property, Plant & Equipment –
Unadj.
40,000
– Accumulated Depr. +
0
Unadj.
– Accounts Payable +
250
Unadj.
– Dividend Payable +
0
Unadj.
– Unearned Revenue +
500
Unadj.
– Notes Payable +
30,000
Unadj.
– Interest Payable +
0
Unadj.
– Income Tax Payable +
0
Unadj.
Stockholders’ Equity
– Common Stock +
1,000
Unadj.
– Additional Paid-In
Capital +
9,000
Unadj.
– Retained Earnings +
0
Unadj.
– Decorating Revenue +
120,000
Unadj.
– Investment Income +
+ Wage Expense –
Unadj.
32,000
+ Utilities Expense –
Unadj.
1,000
+ Telephone Expense –
Unadj.
500
+ Supplies Expense –
+ Rent Expense –
+ Insurance Expense –
+ Depreciation Expense –
+ Interest Expense –
+ Income Tax Expense –
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-18
HANDOUT 4 – 1 SOLUTION
ADJUSTING ENTRIES AND
POSTING TO T-ACCOUNTS
Prepare the required adjusting journal entry for each situation as of December 31, 2014. See the last page
for the unadjusted account balances shown in T-accounts.
(a) Suppose Deana’s had received a $1,800 shipment of supplies in September 2014. When counting the
supplies on December 31, 2014, Deana’s found only $800 worth of supplies on hand.
Debit and credit the accounts affected.
Dec. 31
Supplies Expense (+E, –SE)
1,000
2014
Supplies (–A)
1,000
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
Supplies
(–A)
–1,000
Supplies Exp.
(+E)
–1,000
(b) Suppose Deana’s had paid $12,000 for six months’ rent on November 1, 2014. As of December, 31,
2014, two months’ (November & December) prepaid rent has expired.
Debit and credit the accounts affected.
Dec. 31
Rent Expense (+E, –SE)
4,000
2014
Prepaid Rent (–A)
4,000
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
Prepaid
Rent
(–A)
–4,000
Rent Exp.
(+E)
–4,000
(c) Suppose Deana’s had paid $6,000 for one year’s insurance on June 1, 2014.
Debit and credit the accounts affected.
Dec. 31
Insurance Expense (+E, –SE)
3,500
2014
Prepaid Insurance (–A)
3,500
Ensure the equation still balances and debits = credits.
Assets
=
Liabilities
+
Stockholders’ Equity
Prepaid
Insurance
(–A)
–3,500
Insurance
Exp. (+E)
–3,500