Chapter 4
Adjustments, Financial Statements, and the
Quality of Earnings
ANSWERS TO QUESTIONS
1. Adjusting entries are made at the end of the accounting period to record all
2. The four different types are adjustments for:
(1) Deferred revenues — previously recorded liabilities that need to be adjusted at
the end of the period to reflect revenues that have been earned (e.g., Unearned
Ticket Revenue must be adjusted for the portion of ticket revenues earned in
3. A contra-asset is an account related to an asset that is an offset or reduction to the
4. The net income on the income statement is included in determining ending retained
earnings on the statement of stockholders’ equity and the balance sheet. The
5. (a) Income statement: Revenues (and gains) – Expenses (and losses) = Net Income
(Loss)
6. Adjusting entries have no effect on cash. For deferred revenues and deferred
7. Earnings per share = Net income ÷ Average number of shares of stock outstanding
8. Total asset turnover ratio = Net Sales (or Operating Revenues) ÷ Average Total
Assets
9. The purposes for closing the books at the end of the accounting period are to (1)
transfer the balances in the temporary income statement accounts to retained
10. (a) Permanent accounts — balance sheet accounts; that is, the asset, liability, and
stockholders’ equity accounts (these are not closed at the end of each period).
11. The income statement accounts are closed at the end of the accounting period
because, in effect, they are temporary subaccounts to retained earnings (i.e., a part
of stockholders’ equity). They are used only for accumulation during the accounting
period. When the period ends, these accumulated accounts must be transferred
(closed) to retained earnings. The closing process serves:
12. A post-closing trial balance is a listing taken from the ledger after the adjusting and
closing entries have been journalized and posted. It is not a necessary part of the
ANSWERS TO MULTIPLE CHOICE
1. c
2. a
Financial Accounting, 10/e 4-5
Authors’ Recommended Solution Time
(Time in minutes)
Mini-exercises
Exercises
Problems
Alternate
Problems
Comprehensive
Problems
Cases and
Projects
No.
No.
Time
No.
Time
No.
Time
No.
Time
No.
Time
1
1
10
1
15
1
15
1
60
1
25
2
2
10
2
20
2
20
2
60
2
25
3
3
10
3
20
3
20
3
25
4
4
10
4
20
4
20
4
5
5
15
5
20
5
20
5
25
6
6
15
6
25
6
25
6
40
7
7
10
7
30
7
30
7
35
8
8
20
8
50
9
9
20
9
25
10
10
20
10
11
11
20
12
12
15
13
13
15
14
20
15
15
16
20
1
15
17
20
18
20
19
20
20
20
21
15
22
10
* Due to the nature of this project, it is very difficult to estimate the amount of time
students will need to complete the assignment. As with any open-ended project, it is
possible for students to devote a large amount of time to these assignments. While
Continuing
Problem
MINI-EXERCISES
M4–1.
Hagadorn Company
Adjusted Trial Balance
At June 30
Debit
Credit
Cash
175
Accounts receivable
420
Inventories
710
Prepaid expenses
30
Buildings and equipment
Accumulated depreciation
250
Land
Accounts payable
250
Accrued expenses payable
160
Income taxes payable
50
Unearned fees
90
Long-term debt
1,460
Common stock
100
Additional paid-in capital
300
Retained earnings
150
Sales revenue
2,400
Interest income
60
Cost of sales
780
Salaries expense
640
Rent expense
460
Depreciation expense
150
Interest expense
70
Income taxes expense
5,270
5,270
M4–2.
(1) D
(2) C
(3) A
(4) D
(5) A
(6) B
(7) B
Financial Accounting, 10/e 4-7
M4–3. (1) D
M4–4.
(a)
1. Rent revenue is now earned.
2. Cash was received in the past – a deferred revenue was recorded.
Adjusting entry –
Rent revenue (+R, +SE) ……………………
(b)
1. Depreciation Expense on the equipment is now incurred.
2. Cash was paid in the past when the equipment was purchased — a
Adjusting entry –
Depreciation expense (+E, −SE) ………………
3,200
Accumulated depreciation (+XA, −A) …..
3,200
(c)
1. Insurance expense was incurred in the period.
2. Cash was paid for the insurance in the past – a deferred expense was
Adjusting entry –
Insurance expense (+E, −SE) …………………..
1,250
Prepaid insurance (−A) ……………………..
1,250
M4–5.
Balance Sheet
Income Statement
Transaction
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
a.
NE
–300
+300
+300
NE
+300
M4–6.
(a)
1. Utilities Expense is incurred.
2. Cash will be paid in the future for utilities used in the current period – an
Utilities payable (+L) …………………………
(b)
1. Interest revenue is now earned on the note receivable.
Interest revenue (+R, +SE) ………………..
2. Cash for the interest will be received in the future – an accrued revenue
(c)
1. Wages expense was incurred in the period.
Wages payable (+L) …………………………
2. Cash will be paid in the future to the employees who worked in the current
M4–7.
Financial Accounting, 10/e 4-9
Balance Sheet
Income Statement
Transaction
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
a.
NE
+450
–450
NE
+450
–450
NE
NE
M4–8.
CATENA’S MARKETING COMPANY
Income Statement
For the Current Year
Operating Revenues:
Sales revenue
Total operating revenues
Operating Expenses:
Wages expense
$ 38,500
38,500
19,500
M4–9.
CATENA’S MARKETING COMPANY
Statement of Stockholders’ Equity
For the Current Year
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Total
Stockholders’
Equity
Balance, January 1
$ 30 (1)
$ 670 (2)
$ 2,000 (3)
$ 2,700
Balance, December 31
$ 10,370
Computations:
(1) 800 shares at year end – 500 shares issued during year = 300 shares at beginning
(2) Since the 500 new shares added $2,950 in Additional Paid-in Capital [500 shares x
(3) Since the ending balance in Retained Earnings does not include net income but
Financial Accounting, 10/e 4-11
M4–10.
CATENA’S MARKETING COMPANY
Balance Sheet
At the End of the Current Year
Assets
Current Assets:
Cash
Accounts receivable
Liabilities
Current Liabilities:
Accounts payable
Dividends payable
$ 1,500
2,200
$ 2,400
600
M4–11.
Req. 2
M4–12.
Assets:
Cash
Accounts receivable
$ 1,500
2,200
M4–13.
Sales revenue (−R) …………………………………………
Interest revenue (−R) ………………………………………
38,500
100
Financial Accounting, 10/e 4-13
EXERCISES
E4–1.
Jameson Consultants, Inc.
Unadjusted Trial Balance
At the End of the Current Year
Debit
Credit
Cash
153,000
Accounts receivable
225,400
Supplies
12,200
Prepaid expenses
10,200
Investments
325,000
Buildings and equipment
Accumulated depreciation
18,100
Land
60,000
Accounts payable
96,830
Salaries payable
25,650
Unearned consulting fees
32,500
Income taxes payable
3,030
Notes payable
160,000
Common stock
3,370
Additional paid-in capital
220,000
Retained earnings *
144,510
Consulting fees revenue
2,564,200
Investment income
10,800
Gain on sale of land
6,000
Salaries expense
1,610,000
Utilities expense
25,230
Travel expense
23,990
Rent expense
152,080
Professional development expense
18,600
Depreciation expense
8,000
Supplies expense
21,050
Interest expense
17,200
Totals
3,284,990
* Since debits are supposed to equal credits in a trial balance, the balance in Retained
Earnings is determined as the amount in the credit column necessary to make debits
equal credits (a “plugged” figure).
E4–2.
Req. 1
Types
Accounts to be Adjusted
Deferred Revenues:
Deferred Revenue may need to be
adjusted for any revenue earned
during the period
Deferred Revenue (L) and Product
Revenue and/or Service Revenue (R)
Deferred Expenses:
Other Current Assets may include
supplies, prepaid rent, prepaid
insurance, or prepaid advertising
Any additional use of Property, Plant,
and Equipment during the period
will need to be recorded
Other Current Assets (A) and Selling,
General, and Administrative Expense
(E)
Accumulated Depreciation (XA) and
Cost of Products and/or Cost of
Services (E)
[There may also be a portion of
Depreciation Expense included in
Selling, General, and Administrative
Expense.]
Req. 2
Financial Accounting, 10/e 4-15
Temporary accounts that accumulate during the period are closed at the end of the year
to the permanent account Retained Earnings. These include: Product revenue, service
E4–3.
Req. 1
The annual reporting period for this company is January 1 through December 31.
Req. 2 (Adjusting entries)
Both transactions are accruals because revenue has been earned and expenses
incurred but no cash has yet been received or paid.
(a)
1. Wages expense is incurred.
Wages payable (+L) ………………………..
2. Cash will be paid in the next period to employees who worked in the current
(b)
1. Interest revenue is now earned.
Interest revenue (+R, +SE) ……………….
To record interest earned at year-end.
2. Cash will be received in the future – an accrued revenue needs to be
Req. 3
Adjusting entries are necessary at the end of the accounting period to ensure that all
revenues earned and expenses incurred and the related assets and liabilities are
Financial Accounting, 10/e 4-17
E4–4.
Req. 1
The annual reporting period for this company is January 1 through December 31.
Req. 2 (Adjusting entries)
Both transactions are accruals because expenses have been incurred but no cash has
yet been paid.
(a)
1. Interest expense is incurred.
Interest payable (+L) ………………………..
(b)
1. Utilities expense is incurred.
2. Cash will be paid in the future – an accrued expense needs to be recorded.
Utilities payable (+L) …………………………
To record utilities incurred at year-end.
Req. 3
Adjusting entries are necessary at the end of the accounting period to ensure that all
revenues earned and expenses incurred and the related assets and liabilities are
E4–5.
Req. 1
Prepaid Insurance is a deferred expense that needs to be adjusted each period for the
amount used during the period.
The amount of expense is computed as follows: $4,800 x 3/24 = $600 used
Req. 2
Shipping Supplies is a deferred expense that needs to be adjusted at the end of the
period for the amount of supplies used during the period.
The amount is computed as follows: Beginning balance $13,000
Req. 3
Prepaid Insurance
Insurance Expense
10/1 4,800
AJE 600
AJE 600
Shipping Supplies
AJE 68,000
Req. 4
Balance sheet:
Prepaid insurance $ 4,200
Shipping supplies $20,000
Financial Accounting, 10/e 4-19
E4–6.
Req. 1
Prepaid Advertising is a deferred expense that needs to be adjusted each period for the
amount used during the period.
The amount of expense is computed as follows:
Req. 2
Construction Equipment is a deferred expense that needs to be adjusted at the end of
the period for the amount of the equipment used during the period.
Req. 3
Prepaid Advertising
Advertising Expense
1/1 1,800
AJE 900
AJE 900
End. 900
End. 900
Accumulated Depreciation
132,000 Beg.
34,000 AJE
Construction Equipment
Income statement:
Advertising expense $900 Depreciation expense $ 34,000
Req. 4
E4–7.
Balance Sheet
Income Statement
Transaction
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
E4–3 (a)
NE
+4,000
–4,000
NE
+4,000
–4,000
E4–3 (b)
E4–5 (a)
NE
E4–5 (b)
NE
E4–8.
Req. 1
a.
Accrued expense
b.
Deferred expense
Accrued revenue
d.
Deferred expense
e.
Deferred expense
Deferred revenue
g.
Accrued revenue
Req. 2 Computations
a.
Wages expense (+E, −SE) …………………………..
2,700
Given
Wages payable (+L) …………………………..
2,700
b.
Office supplies expense (+E, −SE) …………………………
675
$450 + $500
Office supplies (−A) …………………………..
675
– $275 = $675 used
c.
Rent receivable (+A) …………………………………………….
1,120
$560 x 2 months
Rent revenue (+R, +SE) …………………………..
1,120
= $1,120 earned
d.
Depreciation expense (+E, −SE) …………………………..
Given
Accumulated depreciation (+XA, −A)
e.
Insurance expense (+E, −SE)…………………………..
Unearned rent revenue (−L) …………………………..
$9,600 x 2/6 =
Rent revenue (+R, +SE) …………………………..
$3,200 earned
g.
Repair accounts receivable (+A) …………………………..
Given
Repair shop revenue (+R, +SE) ……………………