Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-1
Chapter 04
Adjustments, Financial Statements, and
the Quality of Earnings
ANSWERS TO QUESTIONS
1. A trial balance is a list of the individual accounts, usually in financial statement
2. Adjusting entries are made at the end of the accounting period to record all
3. 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
the current period).
(2) Accrued revenues — revenues that have been earned by the end of the
accounting period but which will be collected in a future accounting period (e.g.,
recording Interest Receivable for interest revenues not yet collected).
4. A contra-asset is an account related to an asset that is an offset or reduction to the
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
5. 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
6. (a) Income statement: Revenues (and gains) – Expenses (and losses) = Net Income
(b) Balance sheet: Assets = Liabilities + Stockholders’ Equity
7. Adjusting entries have no effect on cash. For deferred revenues and deferred
8. Earnings per share = Net income ÷ average number of shares of stock outstanding
9. Net profit margin = Net income ÷ net sales
10. An unadjusted trial balance is prepared after all current transactions have been
journalized and posted to the ledger. It does not include the effects of the adjusting
entries. The basic purpose of an unadjusted trial balance is to check the equalities
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-3
11. The closing entry is made at the end of the accounting period to (1) transfer the
balances in the temporary income statement accounts to retained earnings and (2)
12. (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).
13. 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
(1) to correctly state retained earnings, and
(2) to clear out the balances of the temporary accounts for the year just ended so
that these subaccounts can be used again during the next period for
14. 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
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-4
ANSWERS TO MULTIPLE CHOICE
1. c
2. b
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-5
Authors’ Recommended Solution Time
(Time in minutes)
Mini-exercises
Exercises
Problems
Alternate
Problems
Comprehensive
Problems
Cases and
Projects
No.
Time
No.
Time
No.
Time
No.
Time
No.
Time
No.
Time
1
5
1
10
1
15
1
15
1
60
1
25
2
5
2
10
2
20
2
20
2
60
2
25
9
5
9
15
9
50
10
5
10
20
10
25
11
5
11
10
11
*
12
3
12
20
13
15
14
15
15
20
16
20
17
20
18
20
19
10
20
15
* 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
3
3
3
10
3
20
3
20
3
25
4
5
4
15
4
20
4
20
4
5
5
5
10
5
20
5
20
5
25
6
5
6
20
6
25
6
25
6
40
8
5
8
20
8
35
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-6
MINI-EXERCISES
M4–1.
Hagadorn Company
Adjusted Trial Balance
At June 30, 2011
Debit
Credit
Cash
$ 175
Accounts receivable
420
Inventories
710
Prepaid expenses
30
Long-term debt
1,460
Contributed capital
400
Retained earnings
150
Sales revenue
2,400
Interest income
60
Cost of sales
780
Rent expense
460
Depreciation expense
150
Interest expense
70
Income taxes expense
135
$ 5,270
$ 5,270
M4–2.
(1) D
(2) C
(4) D
(5) A
(6) B
(7) B
(8) C
Buildings and equipment
Accumulated depreciation
$ 250
Land
300
Accounts payable
250
Accrued expenses payable
160
Income taxes payable
50
Unearned fees
90
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
M4–3. (1) D
(2) C
M4–4.
(a)
1. Rent revenue is now earned.
2. Cash was received in the past – a deferred revenue was recorded.
3. Amount: $1,000 4 months = $250 earned
Adjusting entry –
Unearned rent revenue (−L) …………………….
250
Rent revenue (+R, +SE) ……………………
250
(b)
1. Depreciation Expense on the equipment is now incurred.
Adjusting entry –
Depreciation expense (+E, −SE) ………………
3,000
Accumulated depreciation (+XA, −A) …..
3,000
(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) …………………..
1,050
Prepaid insurance (−A) ……………………..
1,050
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
M4–5.
Balance Sheet
Income Statement
Transaction
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
a.
NE
–250
+250
+250
NE
+250
M4–6.
(a)
1. Utilities Expense is incurred.
2. Cash will be paid in the future for utilities used in the current period – an
accrued expense needs to be recorded.
3. Amount: $380 given
Adjusting entry –
Utilities payable (+L) …………………………
(b)
1. Interest revenue is now earned on the note receivable.
2. Cash for the interest will be received in the future – an accrued revenue
needs to be recorded.
Interest revenue (+R, +SE) ………………..
3. Amount: $5,000 principal x .14 annual rate x 4/12 of a year = $233
(c)
1. Wages expense was incurred in the period.
2. Cash will be paid in the future to the employees who worked in the current
period – an accrued expense needs to be recorded.
3. Amount: 10 employees x 4 days x $150 per day = $6,000
Adjusting entry –
Wages payable (+L) …………………………
4-9
M4–7.
Balance Sheet
Income Statement
Transaction
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
a.
NE
+380
–380
NE
+380
–380
NE
NE
M4–8.
ROMNEY’S MARKETING COMPANY
Income Statement
For the Year Ended December 31, 2012
Operating Revenues:
Sales revenue
Total operating revenues
Operating Expenses:
Wages expense
Operating Income
Other Items:
Interest revenue
Rent revenue
Pretax Income
Income tax expense
$ 37,650
37,650
19,000
6,830
100
750
7,680
2,700
Net Income
$ 4,980
Earnings per share*
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
M4–9.
ROMNEY’S MARKETING COMPANY
Statement of Stockholders’ Equity
For the Year Ended December 31, 2012
Contributed
Capital
Retained
Earnings
Total
Stockholders’
Equity
Balance, January 1, 2012
$ 700
$ 2,000*
$ 2,700
Balance, December 31, 2012
$ 3,700
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-11
M4–10.
Req. 1
ROMNEY’S MARKETING COMPANY
Balance Sheet
At December 31, 2012
Assets
Current Assets:
Cash
Liabilities
Current Liabilities:
Accounts payable
Accrued expenses payable
Income taxes payable
$ 1,500
$ 2,400
3,920
2,700
Req. 2
The adjustments in M4–4 and M4–6 have no effect on the operating, investing, and
financing activities on the statement of cash flows because no cash is paid or received
at the time of the adjusting entries.
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-12
M4–11.
Revenues:
Sales revenue
Interest revenue (not operating)
Rent revenue (not operating)
Total revenues
Costs and expenses:
Wages expense
Depreciation expense
$ 37,650
100
750
38,500
19,000
1,800
M4–12.
Sales revenue (−R) …………………………………………
Interest revenue (−R) ………………………………………
37,650
100
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
EXERCISES
E4–1.
Paige Consultants, Inc.
Unadjusted Trial Balance
At September 30, 2012
Debit
Credit
Cash
$ 153,000
Accounts receivable
225,400
Supplies
12,200
Prepaid expenses
10,200
Investments
145,000
Buildings and equipment
323,040
Accumulated depreciation
$ 18,100
Land
60,000
Accounts payable
Accrued expenses payable
25,650
Unearned consulting fees
32,500
Income taxes payable
3,030
Notes payable
160,000
Contributed capital
223,370
Retained earnings *
144,510
Consulting fees revenue
Investment income
10,800
Gain on sale of land
6,000
Wages and benefits expense
Utilities expense
25,230
Travel expense
23,990
Rent expense
152,080
Professional development expense
18,600
Other operating expenses
188,000
General and administrative expenses
321,050
Interest expense
17,200
Totals
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-14
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)
Any additional use of Property, Plant,
and Equipment during the period
will need to be recorded
Accumulated Depreciation (XA) and
Cost of Products and/or Cost
of Services (E)
Accrued Expenses:
Interest incurred on Short-term Note
Payable and Long-term Debt will
need to be recorded
Accrued Liabilities (L) and Interest
Expense (E)
Req. 2
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
provided will need to be recorded
Product Revenue and/or
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
E4–3.
Req. 1
Req. 2 (Adjusting entries)
(a)
1. Wages expense is incurred.
2. Cash will be paid in the next period to employees who worked in the current
period – an accrued expense needs to be recorded.
3. Amount: $7,000 given
Adjusting entry –
Wages payable (+L) …………………………
(b)
1. Interest revenue is now earned.
2. Cash will be received in the future – an accrued revenue needs to be
recorded.
3. Amount: $2,000 given
Adjusting entry –
Interest revenue (+R, +SE) ………………..
Req. 3
Adjusting entries are necessary at the end of the accounting period to ensure that all
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-16
E4–4.
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: $3,600 x 3/24 = $450 used
Adjusting entry:
Shipping supplies expense (+E, −SE) …………………… 51,000
Shipping supplies (−A) ………………………………. 51,000
Req. 3
Prepaid Insurance
Insurance Expense
10/1 3,600
AJE 450
AJE 450
End. 3,150
End. 450
Beg. 11,000
Purch. 60,000
AJE 51,000
End. 20,000
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
E4–5.
Balance Sheet
Income Statement
Transaction
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
E4–3 (a)
NE
+7,000
–7,000
NE
+7,000
–7,000
E4–3 (b)
E4–4 (a)
NE
E4–4 (b)
NE
E4–6.
Req. 1
a.
Accrued expense
b.
Deferred expense
c.
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)…………………………..
Prepaid insurance (−A) …………………………..
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) ……………………
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-18
E4–7.
Req. 1
a.
Accrued revenue
b.
Deferred expense
c.
Accrued expense
Req. 2 Computations
a.
Accounts receivable (+A) …………………………..
2,700
Given
Service revenue (+R, +SE) …………………………..
2,700
Advertising expense (+E, −SE) …………………………..
$1,200 x 9/12 =
Prepaid advertising (−A) …………………………..
900
$900 used
Interest expense (+E, −SE) …………………………..
$250,000 x .12
incurred
d.
Unearned storage revenue (−L) …………………………..
750
$4,500 x 1/6 =
Storage revenue (+R, +SE) ………………………….
750
$750 earned
e.
Depreciation expense (+E, −SE) …………………………..
22,000
Given
Accumulated depreciation (+XA, −A)
22,000
Supplies expense (+E, −SE) …………………………..
$16,500 +
Supplies (−A) ……………………………………………..
= $50,100 used
g.
Wages expense (+E, −SE) …………………………..
Given
Wages payable (+L) …………………………..
d.
Deferred revenue
e.
Deferred expense
g.
Accrued expense
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
E4–8.
Balance Sheet
Income Statement
Transaction
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
(a)
NE
+2,700
–2,700
NE
+2,700
–2,700
(b)
–675
NE
–675
NE
+675
–675
(d)
NE
NE
+12,100
(e)
NE
NE
(g)
E4–9.
Balance Sheet
Income Statement
Transaction
Assets
Liabilities
Stockholders’
Equity
Revenues
Expenses
Net
Income
(a)
+2,700
NE
+2,700
+2,700
NE
+2,700
(b)
NE
NE
(d)
NE
(e)
NE
NE
NE
+50,100
(g)
NE
–3,800
NE
–3,800
Chapter 04 – Adjustments, Financial Statements, and the Quality of Earnings
4-20
E4–10.
Debit
Credit
Independent Situations
Code
Amount
Code
Amount
a.
Accrued wages, unrecorded and unpaid at
year-end, $400 (example).
N
400
G
400
e.
Service revenue collected in advance,
$800.
A
800
I
800
f.
Depreciation expense for the year, $1,000.
O
1,000
E
1,000
g.
yet recorded or paid, $220.
year-end.
account, $460. Give the closing entry at
year-end.
At year-end, interest on note payable not
P
220
H
220
E4–11.
Selected Balance Sheet Amounts at December 31, 2012
Assets:
Equipment (recorded at cost per cost principle)
$12,000
Accumulated depreciation (for one year, as given)
(1,200)
Net book value of equipment (difference)
10,800
Office supplies (on hand, as given)
Prepaid insurance (remaining coverage, $600 x 18/24 months)
Expenses:
Depreciation expense (for one year, as given)
Office supplies expense (used, $1,600 – $400 on hand)
Insurance expense (for 6 months, $600 x 6/24 months)
collected at year-end, $600.
Dividends declared and paid during the
year, $900.
K
900
A
900
$400; supplies on hand at year-end, $160.