Adjusting Entries

A. Selling inventory on account is typically recorded automatically in the accounting system when the goods are shipped to the customer. Supplies and prepaids get used up and typically require an adjusting entry. Paying cash before or after an expense is incurred will require an adjusting entry.

C. Revenue increases when goods are provided and the customer must pay. When the customer has not paid a receivable occurs which increases an asset. If cash is received in the same time period the goods are provided an adjustment is not required. Revenues and expenses are not recorded together in the same adjustment (a.). Revenues increase owner’s equity (d.).

C. This is bad debt expense. Increasing an expense is a debit. The account that is always used with bad debt expense is allowance for uncollectible accounts. The bad debt expense is the debit, so the allowance account is the credit. The allowance account is a contra asset account used to show the decrease in the asset. (The allowance account works just like accumulated depreciation).

B. Accrued expenses is a liability and an increase to a liability is a credit. The company owes because it was provided a service, which is an expense. An increase to an expense is a debit.

B. Using supplies is recorded with a credit to supplies. This is a decrease to the asset. When an asset is used up it is also an expense. The expense must be increased with a debit (c.). The company must record the expense that has been incurred with an adjusting journal entry.

a. interest revenue – used when interest is earned and not yet received

b. interest payable – used when interest has been incurred and not yet paid

c. accumulated depreciation – used when a long term asset has been used

d. supplies expense – used when the asset supplies is used up and you have less than is currently recorded the supplies account

e. allowance for uncollectible accounts – used when the company expects that not all amounts owed from customers will be collected.

f. accounts receivable – used when goods are provided and not yet recorded

g. rent expense – used when time goes by and the service of using the facility has been provided

h. prepaid insurance – used when time goes by and the service of insurance coverage has been provided

i. salaries payable – use when the employees work and have not yet been paid

j. tax expense – use when you compute the amount you owe the government for taxes

k. revenue – use when the amount collected from the customer is more than the amount earned

l. never use the cash account in an adjusting journal entry. Adjustments are made to revenue or expense accounts when cash collected or paid occurs in a different period than the current period.

You must correct what the company has already done.  Correct means the asset = have, the liability = owed, the revenue = earned this period only, the expense = incurred this period only.   Use the information provided to determine what is currently recorded and adjust it.

a.  On June 1, of the current year a cash payment of $4,200 was paid for a two-year policy for insurance coverage.  The account “insurance expense” was debited when the payment was made.

Paying for two years ahead of time is a prepaid expense.   The prepaid expense account was not used and has a 0 balance.  The prepaid expense account must have the balance of what is left on December 31st.  The insurance expense account must be equal to the amount that was used/provided this period.  

$4,200 / 24 months = $175 per month           

Provided from June 1 to December 31 = 7 months provided x $175 = $1,225 provided  = expense so insurance expense must be $1,225.

Insurance expense currently has $4,200 so you must decrease this account by $2,975 to get to the amount of $1,225 that was provided.

Prepaid Insurance               $2,975
       Insurance Expense                $2,975

When you reduce the expense, the same amount goes to the asset prepaid, because this is the part that has not yet been used.

17 months not used x $175 = $2,975 prepaid 

The adjusting entry you make must make the balance in the expense account what was provided and the balance in the asset account the future benefit.

b.  The “supplies” account had a balance of $3,400 at the beginning of the period.  Supplies in the amount of $6,500 were purchased and recorded in the “supplies expense” account.  At the end of the year a count was done and it was determined that $2,200 of supplies remained on hand.

First – record what is currently in the two accounts.  The company recorded the purchase of supplies as an expense assuming it would all be used this period.
If it is not the amount that was used, an adjustment must be made.

The asset supplies is what the company has.  The company really has 2,200 so the balance in supplies must be 2,200.   To get supplies to 2,200 you must decrease it by 1,200 which is done with a credit.

Supplies Expense               1,200
       Supplies                                    1,200

When supplies are used up, this is an expense.  You must also increase the expense with a debit.

c.  The company has a balance of $45,800 in the “accounts receivable” account on December 31st.  Work was performed this period and the customer has not been invoiced for $13,000.

If the company has not invoiced the customer, the company has not yet recorded the revenue.  Work has been performed this period so revenue must be recorded this period. The balance in the accounts receivable account is for other work performed and you must add this amount to it, since it is also owed.

Accounts Receivable        13,000
       Service Revenue                  13,000

d.  The company borrowed $200,000, 9% interest, on April 1st, of the current year.  Interest is paid each January 1st.

Borrowing money and agreeing to pay interest causes interest expense to be incurred as time passes.  The amount of interest is calculated by principle x rate x time

200,000  x .09 x   9 / 12 = $13,500                         

Interest Expense               13,500
       Interest Payable                  13,500

A liability must also be recorded since interest has not been paid as of 12/31 and is owed.

e.  Three years ago the company purchased a building for $100,000.  The unadjusted balance in the accumulated depreciation account is $8,000.

Using a long term asset to produce revenues requires depreciation expense to be recorded.  An equal amount is recorded every year. Since the building has been used for 2 prior years, $4,000 per year was recorded.  The 3rd year has not yet been recorded and an adjusting entry must be made.

Depreciation Expense         4,000
       Accumulated Depreciation  4,000

Accumulated depreciation is always credited when depreciation expense is recorded.

f.  The company received $12,000 from a customer as payment for services that will be provided equally over one year beginning June 1st.  The cash was received on May 1st of the current year and was recorded as “unearned revenue”.

Only amounts not yet earned on 12/31 should be in unearned revenue.
Amounts earned this period must be recorded as revenue this period.

$12,000 / 12 months = $1,000 per month   x 7 months earned = $7,000 earned

If $7,000 is earned, $7,000 must be recorded to revenue.  The amount earned is no longer unearned, so unearned revenue must be decreased with a debit.

Unearned Revenue               7,000
       Service Revenue                      7,000

The debit to unearned revenue reduces the credit balance in this account to $5,000, which is equal to the 5 months (Jan 1 to May 31 of next year) service must be provided.

When cash is received does not matter.  Revenue is recorded for the amount earned.

a.  The prepaid insurance account shows a debit balance representing the cost of a 2 year fire insurance policy purchased on April 1st of the prior year for $8,800.

The prepaid insurance account is the asset and it should have a balance of what the company has paid ahead of time on December 31st  the year.   

$8,800 / 24 months = $366.67 per month x 9 months used = $3,300 used is the expense this year

24 months – 9 months used last year – 12 months used this year = 3 months left x $366.67 = $1,100 left = the balance of prepaid insurance must be on 12/31

12 months has been used this year and you must reduce the prepaid account for 12 months x $366.67 = $4,400.  An asset used is also an expense

Insurance Expense           $4,400
       Prepaid Insurance               $4,400

b.  On October 1st of the current year the “rent revenue” account was credited for $4,000 when cash was collected for rent revenue for a 4 month rental beginning November 1st.

Rent revenue must only have the amount earned this period.  The company has earned from November 1 to December 31st  = 2 months.

$4,000 / 4 months = $1,000 per month x 2 months earned = $2,000 earned = revenue

Revenue currently has $4,000 and must be reduced by $2,000 to get to the $2,000 earned.  Revenue is decreased with a debit.

Revenue                             2,000
       Unearned revenue               2,000

The amount that is not earned is unearned revenue and this must be recorded with a credit to the liability.   

c.  The balance in the “prepaid advertising” account on January 1 of the current year was $2500.  Purchase of advertising materials for $1,400 during the year was recorded in the “advertising expense” account.  On December 31, advertising materials that cost $1,250 are on hand.  

Begin by putting the amounts given in the accounts.

The company recorded amounts paid to advertising expense assuming this was the amount that would be used this period.  If it is not, an adjusting entry must be made. You really have $1,250 so the prepaid advertising account must also have a balance of 1,250.    Reduce prepaid advertising (credit) to get it to be what you really have (2,500 – 1,250 = 1,250 adjustment).

Advertising Expense              1,250
       Prepaid Advertising                1,250

Since you do not have as much as you had recorded, you have used more.  
The amount that you have used must be recorded as an expense.

d.  “Office supplies expense” was debited when office supplies of $1,250 were purchased during the year.  On December 31st, the balance in the account “office supplies” is $0 and office supplies of $320 are on hand.

The company recorded purchases to office supplies assuming all supplies purchased would be used.  If this is not true, an adjusting entry must be made.

The amount on hand of $320 must be the balance in the asset account supplies.  The current balance is $0, so you must increase this account by $320 to get it to be what you really have on 12/31.

Supplies                                    320
       Supplies Expense                   320

The supplies account is reduced with a credit because you did not use as much as you had originally recorded, so you must reduce some of the expense.

e.  The company signed a note receivable in the amount of $10,000 carrying 8% annual interest on  May 1st.  Principle and interest is to be paid on April 30th.  

A note receivable means the company loaned money in return for earning interest.   The company earns interest as time passes. Interest will be collected on April 30th next year and has not yet been collected (a receivable).  Interest has been earned and must be recorded.

$10,000    x .08 x  8/12 (May to Dec) = $533  amount earned, not yet collected

Interest Receivable                 533
       Interest Revenue                       533

f.  On March 1st of the prior year the company loaned $50,000 to an officer of the company.  The loan carries an interest rate of 7% and the loan and all interest must be repaid in 2 years.

This is a note receivable and the company earns interest as time passes.  

Principle  x  Rate  x  Time

$50,000  x  7%  x  12/12 (Jan to Dec) = $3,500 earned this year, not yet collected

Important:  You record the amount earned this year only.  They have used your money for the entire year this year.   The adjustment made last year would be for the partial year amount.  You are adjusting for this year, not last year and not both years, since you made last years adjustment last year.

Interest Receivable           3,500
       Interest Revenue                 3,500