Adjusting Entries

A. A credit to wages payable is an increase. You owe your employees more when they have worked for you, which is an increase in an expense (debit). An increase in expenses is a decrease to net income.

C. Depreciation expense is the cost of using a long-term asset during this period. It has no relationship to fair market or appraised value. It often represents the replacement cost of the wear and tear that has occurred as the asset is used, but this is not the purpose of recording depreciation expense (some assets like buildings actually appreciate as they are used).

C. The use of a long-term asset is recorded as depreciation expense. Expenses increase with a debit. The credit always used with depreciation expense is accumulated depreciation.

C. This is the definition of a prepaid expense. (a. & b.) are liabilities. Depreciation expense is not paid.

A. Adjusting entries do not use a revenue and an expense in the same entry. The company can not provide and be provided at the same time. Adjusting entries always use a balance sheet account and an income statement account. Adjusting entries adjust revenues or expenses and do not have both in the same adjusting entry.

a.  The “prepaid rent” account contains a balance of $6,000 representing payment made on October 1st of the current year for six months rent for a warehouse.  

Adjust the account the company has already recorded – “prepaid rent”

The prepaid rent account balance must be equal to the amount of future benefit on December 31st.  The cost per month is $6,000 / 6 months = $1,000 per month.

As of December 31st, the company has 3 months of future benefit (Jan – Mar of next year).  3 months of benefit was used up as time passed (October to December).

To get the prepaid account balance of $6,000 to the $3,000 future benefit as of 12/31 it must be decreased by $3,000.  Assets are decreased with a debit.

Rent Expense                    3,000
       Prepaid Rent                          3,000

The use of the asset is also an expense that must be recorded.  Expenses increase with a debit. The $3,000 rent expense is 3 months used up this period (October to December)

b.  The company borrowed $50,000 at a 6% interest rate on August 1st of the current year.  No interest was paid during this year.

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

principle  x rate x   time

50,000  x .06   x 5 / 12  months out of the year
=  $1,250

Interest Expense                   1,250
       Interest Payable                      1,250

A liability must also be recorded since interest has not yet been paid on 12/31 and is owed.  Liabilities increase with a credit.

c.  The company received $12,000 on August 1st  of the current year for the use of a portion of its parking lot from a neighboring business for one year and recorded it all to “unearned rent revenue”.  

Adjust the account that the company already used – “unearned rent revenue”.
The company has provided service as of 12/31 and revenue must be recorded for the amount earned.   Unearned revenue is decreased for the same amount. The amount earned is calculated by:

$12,000  / 12 months = $1,000 x 5 months provided = $5,000 earned

Unearned Revenue               5,000
       Rent Revenue                             5,000

The amount earned was originally put in unearned revenue and since it is no longer owed, unearned revenue must also be reduced.

Unearned revenue is now $7,000 (12,000 original – 5,000 adjust) representing the 7 months the customer has paid for prior to use.  This is the amount still owed on 12/31.

d.  Services provided to clients during December in the amount of $3,000 were recorded as accounts receivable and revenue.

No adjustment is required.  The services were provided and recorded as revenue in the same period.

An adjustment is required when revenue is earned and not recorded or when too much revenue has been recorded and some of it was not earned this period.

e.  The beginning balance in the supplies account was $150.  Supplies purchased during the year, recorded to the “supplies” account, totaled $2,400.  Supplies costing $1,500 remained on hand at year-end.

First – record what is currently in the supplies accounts.  The company recorded the purchase of supplies as an asset assuming they would not be used this period.
If some are used an adjustment must be made to show the asset used, which is supplies expense.

The asset supplies is what the company has.  The company really has 1,500 so the balance in supplies must be 1,500.   To get supplies to 1,500 you must decrease it by 1,050 which is done with a credit.

Supplies Expense        1,050
       Supplies                             1,050

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

a.  The “rent revenue” account contains a balance of $10,000, representing payment received on August 1st of the current year for 6 months use of the warehouse.

You must adjust the revenue account to what has been earned this period, not what is collected.

First determine how much is earned per month.  Only amounts earned this period can be in the revenue account.

$10,000 / 6 = $1,666.67 is earned per month x 5 months = $8,333 total earned

To get the revenue account current balance of 10,000 to 8,333 you must decrease it by 1,667.  Decrease a revenue with a debit

Rent Revenue                             1,667
       Unearned Rent Revenue        1,667

Revenue that is not earned yet is unearned revenue.
This liability must also be recorded with a credit.

b.  The company borrowed $75,000 at a 6% interest rate on March 1st of the prior year. No interest was paid during this year.

This is a note payable and the company incurs interest as time passes.  This has not yet been recorded since no payment is made.

Principle    x Rate x   Time

$75,000    x .06 x  12/12 (Jan to Dec) = $4,500 incurred, not yet paid

Important:  You record the amount earned this year only.  You have used the 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 already made last years adjustment last year.

Interest Expense                    4,500
       Interest Payable                      4,500

c.  The company loaned $100,000 to another company on November 1st of the current year.  The note carries interest of 12%.  No cash has been exchanged for interest.

This is a notes receivable which means the company loaned money in return for earning interest.  The company earns interest as time passes. Interest has not yet been collected so nothing related to interest has been recorded.  Interest has been earned and is owned to the company.

Principle  x  Rate  x  Time

$100,000 x 12% x 2/12 (Nov to Dec) = $2,000 amount earned, not yet collected.

Interest Receivable               2,000
       Interest Revenue                      2,000

d.  Services provided to clients during December, in the amount of $3,000 has not been recorded.  The customer is expected to pay in January.

Services were provided this period, so revenue must be recorded this period.
The customer owes the company and a receivable must be recorded this period.

Accounts Receivable             3,000
       Service Revenue                      3,000

e.  Supplies purchased during the year, recorded to the “supplies expense” account totaled $2,400.  Supplies costing $1,500 remained on hand at year-end. The beginning balance of the “supplies” account was $1,600.  Supplied purchased during the year and recorded to the “supplies” account was $1,200.

First – record what is currently in the two accounts.  The company recorded the purchase of supplies as an asset when they assumed it would not be used this period and to supplies expense for those assumed to be used this period.  If some are used an adjustment must be made to show the asset used and which is also an expense.

The asset supplies is what the company has.  The company really has 1,500 so the balance in supplies must be 1,500.   To get supplies to 1,500 you must decrease it by 1,300 which is done with a credit.

Supplies Expense                1,300
       Supplies                                      1,300

Supplies that are no longer on hand have been used up which is an expense (increased with a debit).

a.  The company recorded $12,000 to rent expense when payment was received on September 1st of the current year for six months of rent for a warehouse.  

Adjust what is currently recorded to “rent expense”

The company recorded the entire payment to expense which means all of the rent was incurred which is not true on 12/31.  The rent expense account must equal the rent incurred for this period only.

$12,000 / 6 months = $2,000 per month incurred x 4 months = $8,000 incurred (used)

If $8,000 was incurred, then $8,000 must be the balance in the rent expense account.

To get the current rent expense balance of $12,000 to $8,000 it must be decreased (credit) by $4,000.

Prepaid Rent                           4,000
       Rent Expense                             4,000

The rent that was paid for and is not yet incurred is a prepaid.  The prepaid must be increased with a debit. The company has 2 months paid ahead left. (2 x 2,000 = 4,000)

b.  The company borrowed $50,000, at a 6% interest rate on August 1st of the current year.   Accrued interest is paid on September 30th and June 30th.  

This is a note payable and the company incurs interest as time passes.  The amount not yet recorded is the amount not yet paid.

Principle    x Rate x   Time

$50,000 x 6% x 3/12 (Oct to Dec) = $750 incurred and not yet paid

Interest is paid on September 30th.  When it is paid the amount interest expense up to this point is also recorded.  The amount that has not yet been paid is the amount of the adjusting entry.

Interest Expense                       750
       Interest Payable                          750

c.  The company received $9,000 on August 1st of the current year for the use of a portion of the warehouse for one year and recorded it all to “rent revenue”.

Determine the amount that has been earned this year. This is the amount that must be recorded for revenue on 12/31 (not the amount collected).

$9,000 / 12 months =  $750 x 5 months earned = $3,750 earned   

The balance in the rent revenue account is currently $9,000.  To get the balance to be $3,750 earned, you must decrease (debit) the revenue account by $5,250.

Rent Revenue                             5,250
       Unearned Rent Revenue        5,250

Revenue that is not earned is unearned.  The company still owes the other company 7 months of rent, a liability called unearned revenue.   

7 months x $750 per month = 5,250 still owed – unearned revenue

No liability was recorded when payment was recorded.  The liability must be recorded with a credit.

d.  Equipment that cost $75,000 and has a useful life of 10 years was used to produce revenues the entire year.  

Using long term assets to produce revenues is called depreciation expense.  This is not recorded during the period because cash is not paid. The adjustment records the cost of using the equipment during the period.

Depreciation Expense        7,500
       Accumulated Depreciation   7,500

Depreciation Expense = Cost divided by useful life

$75,000   /  10 years

e.  Equipment that cost $75,000 and has a useful life of 10 years was used to produced revenues for the first five months of the year.  

Using long term assets to produce revenues is called depreciation expense.  This is not recorded during the period because cash is not paid. The adjustment records the cost of using of the equipment during the period.  This period the equipment was only used for 5 months.  The annual expense must be multiplied by 5 /12 to get the expense for 5 months.

Depreciation Expense             3,125
       Accumulated Depreciation    3,125

Depreciation Expense =  Cost divided by useful life x part of the year used

$75,000   / 10 years   x 5 /12 = 3,125

f.  The company estimated that $2,000 would not be collected from customers for current period sales.

Amounts not expected to be collected from customers is called bad debt expense.  
This must be estimated and recorded in the same period as the related sales (matching principle).  The following accounts are always used.

Bad Debt Expense                 2,000
       Allowance for Uncollectible Accounts   2,000

Note:  If the problem states a current balance in the allowance for uncollectible accounts account, the adjustment must be for the difference in what is not expected to be collected and the current balance.  For example: If the balance is 5,000 and the amount that is not expected to be collected is 8,000, the adjustment will increase (credit) the allowance account for 3,000. Bad debt is also debited for the same amount.