Adjusting Entries

Hard Test

Hard Test

Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.

1. Which adjustment is an accrual?

a. Interest earned and collected
b. Wages incurred and not yet paid
c. Insurance paid before use
d. Rent paid during the period it is used

Check Your Answer
B. An accrual means an expense has been incurred and not yet paid for or a revenue has been earned and not yet collected. (a.) is not an accrual because the cash was collected. (c.) is a prepaid, the expense is deferred until incurred. (d) is not an adjustment because the cash is paid in the same period it is incurred.
2. Which of the following accounts will always require an adjustment in the future?

a. interest receivable
b. prepaid rent
c. sales
d. wages payable

Check Your Answer
B. Prepaid expenses will always require and adjustment when they are used as time goes by. Receivables and payables will be collected and paid in the future; however, this is not an adjustment, it is a regular transaction. Sales are typically recorded automatically by the accounting system when the goods are provided.
3. The accumulated depreciation account at the end of the first year of operations will

a. the adjustment made to property expense
b. the book value of property, plant & equipment
c. depreciation expense for the current year
d. depreciation expense at the beginning of the year

Check Your Answer
C. Accumulated depreciation is the cumulative amount of depreciation expense. If there is only one prior period then depreciation expense will be equal to accumulated depreciation, (both with one year’s amount). Depreciation expense is always recorded at the end of the period after the asset has been used (d.) Book value is equal to the cost of the asset less accumulated depreciation (b.). Property expense is not an account name, it is always called depreciation expense.
4. A total of $18,000 cash was paid to employees for work performed in the current period. The next payment made to employees will be $6,000. Employees earned $1,000 in the current period that has not yet been paid. Total wage expense for the period should be reported as

a. $18,000
b. $19,000
c. $ 21,000
d. $16,000

Check Your Answer
B. Total wage expense for the period must equal the total amount worked/incurred during the period. How much is paid does not matter. The amount incurred is $18,000 work performed this period and $1,000 employees earned in the current period.
5. A deferral must be recorded when

a. revenues are earned and collected
b. revenues are collected prior to being earned
c. wages are incurred and not paid
d. a long-term asset is used

Check Your Answer
B. A deferral occurs when an amount is paid or collected prior to the service being provided. Prepaids and unearned revenues are deferrals.
6. The adjusting journal entry required to record interest earned will affect the
accounting equation as follows:

    Assets           Liabilities      Owner’s Equity
a. no effect       increase       decrease
b. increase       no effect       increase
c. decrease       increase       no effect
d. increase       decrease       no effect

Check Your Answer
B. Interest earned is an increase in revenue, which increased owner’s equity. Interest earned is in exchange for an asset which increases (cash or accounts receivable). Liabilities are not impacted when interest is earned because interest is not collected before it is earned.
7. What do you call it when a prepayment is made?

a. deferral
b. accrual
c. payable
d. receivable

Check Your Answer
A. A prepayment is called a prepaid expense. This is a deferral. The expense is deferred (not recorded) until it is incurred.
8. Rent was prepaid for 2 years. The adjustment that must be made at the end of the second year will

a. only include the cost of the current period
b. include the cost incurred since the prepayment was made
c. increase an asset and decrease an expense
d. both a. & c.

Check Your Answer
A. Prepaid rent must be adjusted at the end of each period for the amount that was used during that period. An adjustment would have been made for the first year. The adjustment made at the end of the second year is for what is used in the second year only. The adjustment will decrease the asset and increase an expense for the amount of the asset used (d.).
9. An expense must be recorded in an adjusting journal entry when

a. the company paid for the service incurred this period in the prior period
b. the company paid for the service in the current period and has not been provided the service
c. the company used the asset in the period payment was made
d. the company will use the asset beginning next period

Check Your Answer
A. When the company paid for the service in the prior period a prepaid was recorded. An adjustment is made to reduce the prepaid when the asset is used. (b. & d) are prepaids and the expense has not yet been incurred so no adjustment is made. (b. and d.) are prepaids that will be adjusted when the service if provided. (c.) does not require an adjustment since payment is made in the same period.
10. If a company does not make an adjusting journal entry for depreciation expense

a. assets will be understated and expenses will be understated
b. assets will be overstated and expenses will be overstated
c. assets will be overstated and expenses will be understated
d. expenses will be understated and liabilities will be understated

Check Your Answer
C. The adjustment for depreciation expense increases the expense, which decreases net income and increases a contra asset, which decreases assets. If this entry is not made, assets will be too high (overstated) and expenses will be too low (understated).
11. The following accounts/situations indicate that an adjustment must be made. State the accounts that are most often related to the following accounts why an adjusting journal entry is made

a. Prepaid Insurance
b. Notes Receivable
c. Notes Payable
d. Property, Plant, & Equipment
e. Accounts Receivable
f. Supplies
g. Government tax
h. Investment in Bonds

Check Your Answer
a.  Insurance expense 

Using an asset is an expense.  The expense must be recorded in the period it is used not the period it is paid.

b.  Interest receivable – debit     and Interest revenue – credit   

Notes receivable is recorded when the company provides money in exchange for earning interest.  A receivable is recorded if the cash for interest has not yet been collected. If cash is collected, not adjustment is necessary because the revenue is recorded when the cash is collected.  

You must use the account interest receivable because notes receivable is for the principle only

c.  Interest expense – debit   and Interest payable – credit

Notes payable is recorded when the company borrows money in exchange for paying interest.  The service provided is the use of the money which is an expense called interest expense. When the expense has not yet been paid, it is owed, and the liability must also be recorded.

d.  Depreciation expense – debit   and Accumulated Depreciation – credit

Using a long-term asset is an expense called depreciation expense.  Any time a company is using long term assets to produce revenue they must make the adjustment to record depreciation expense.  Accumulated depreciation is always the credit. 

e.  Sales or Service Revenue – credit

This adjustment must be made when the company has provided the goods or services and it has not yet recorded this in the accounting records. The entry to record the revenue is usually recorded automatically in the accounting records when the goods are shipped, however, if it does not get recorded for some reason, you must make an adjustment.  The credit to service revenue usually must be made because you forgot to invoice a customer for services performed.

f.  Supplies expense 

Using an asset is an expense.  As supplies are used during the period nothing is recorded because cash is not paid as they are used.  An adjustment must be made to show what is used during this period.

g.  Income Tax expense – debit and
Income Tax payable  – credit

Taxes are accessed as income is earned and paid at a later date.   
The expense must be recorded in the same period the revenues are earned.

h.  Interest receivable – debit    and   
Interest Revenue – credit

Investments in bonds are made for the purpose of earning interest from excess cash.  The earnings process is revenue. If the revenue has not yet been collected an entry to record the revenue must be made and a receivable is also recorded.

12.  Describe the situation that will cause the following adjusting journal entry to be made.

a.   Rent Expense
             Prepaid Rent Expense

b.   Supplies
             Supplies Expense

c.   Revenue
             Unearned Revenue

d.   Interest Expense
             Interest Payable

e.   Depreciation Expense
             Accumulated Depreciation

f.   Accounts Receivable
             Service Fees

g.   Interest Receivable
             Interest Revenue

h.  Rent Receivable
             Rent Revenue

Check Your Answer
a.   Rent Expense
             Prepaid Rent Expense

Rent was paid for prior to using the facility or equipment.  As time passes and the service is provided an expense must be recorded and the asset decreased because future benefit is less.

b.   Supplies
             Supplies Expense

Supplies were purchased during the period and recorded as an expense assuming all supplies would be used during the period.  At the end of the period it was determined some supplies were still left. The expense must be reduced for the supplies not yet used and the additional asset the company still has must be recorded.   In this case, the company recorded too much expense and must take some back for the asset not yet used.  

c.   Revenue
             Unearned Revenue

Revenues were recorded when cash was received assuming the revenues would be earned by the end of the period.  Some were not yet earned this period and must be taken out of revenues and recorded as unearned revenues.

d.   Interest Expense
             Interest Payable

The company has a note payable that incurs interest.  The amount incurred during this period that has not been paid must be recorded.  The amount is determined by principle x rate x time.

e.   Depreciation Expense
             Accumulated Depreciation

The company is using long term assets (P/P/E) to produce revenue.  The expense must be recorded in the same period the revenue is recorded (matching).

f.   Accounts Receivable
             Service Fees

A service was provided to a customer and the company forgot to invoice the customer.  This adjustment is recorded when it is discovered that a service was provided and not yet recorded.

g.   Interest Receivable
             Interest Revenue

The company loaned money to another party and is charging interest for the use of the money.   Interest is earned which is a revenue that must be recorded and a receivable is recorded when the cash has not yet been collected.   

h.  Rent Receivable
             Rent Revenue

The company is providing the use of an asset to another company and the service has been provided and the other company has not yet paid. 

13.  The account balances for the Hartford Co. on December 31st before adjusting entries are made are:

Accounts Debit Credit
Cash 15,000
Accounts Receivable 35,000
Supplies 12,000
Prepaid Insurance 8,000
Equipment 82,000
Accumulated Deprec. 20,000
Note Payable 10,000
Unearned Revenues 6,000
Capital Stock 1,000
Retained Earnings (1/1) 94,000
Sales 42,000
Salary Expense 4,000
Supplies Expense 12,000
Loss on Sales of Equipment 10,000
Gain on Sale of Investments 5,000

Additional Information, not yet recorded:

a.  Supplies on hand at year end totaled $18,000
b.  Unexpired prepaid insurance at the end of the year totaled $4,000.
c.  The cost of using the equipment totaled $10,000 for year.
d.  The note payable has an interest rate of 8%. The note was signed on September 1st of the current year
e.  Salaries expense, unpaid and unrecorded, totaled $3,000.
f.   Revenues unearned total $1,000 at year end.

Prepare all required adjusting journal entries for this year.

Check Your Answer
a.  Supplies                                 6,000
            Supplies Expense                  6,000

The asset supplies must equal what the company really has.  The account shows $12,000 so another $6,000 must be added to get to the $18,000 the company really has.   Not enough assets means too much expense was recorded and the expense must be decreased.

b.  Insurance Expense               4,000
            Prepaid Insurance                   4,000

The balance in the asset prepaid insurance must be the amount that the company still has paid ahead of time.  This is $4,000, so the balance of $8,000 must be decreased by $4,000 to get to the $4,000 left. The amount used this period is also an expense. Using an asset always is an expense.

c.  Depreciation Expense 10,000
            Accumulated Depreciation 10,000

There is not amount for depreciation expense yet so this must be recorded.  
The company has P/P/E so they will have an adjustment for depreciation.

d.  Interest Expense                       267
            Interest Payable                         267

interest incurred is calculated:  principle x rate x time = interest expense
10,000 x .08 x 4/12 = $266.67 round to $267

You know no interest has been paid this period yet because there is no balance for interest expense yet.  You must record the entire amount incurred this period.  

e.   Salaries Expense                   3,000
            Salaries Payable                       3,000

Incurred means an expense occurred when the service was provided to the company.  This expense must be recorded in the period incurred; you can not wait to record the expense when it is paid later.  The unadjusted salary expense amount of $4,000 has been incurred and paid and you will must add to the expense the other $3,000 incurred that has not yet been paid.

f. Unearned revenues                   5,000
            Revenues                                     5,000

The current balance in unearned revenues is 6,000 and this must be 1,000, the amount that is still owed.  To get the balance in unearned revenue to $1,000 that you now owe you must decrease unearned revenues by $5,000.  Revenue that is no longer unearned is earned and revenue must also be increased.