Skip to main content
Chemistry LibreTexts

Chapter 3: Financial Accounting and Adjusting Entries

  • Page ID
    180516
  • Chapter 3: Financial Accounting and Adjusting Entries

     

    Chapters 1 and 2 described the recording and reporting of economic transactions in detail. However, the account balances used to prepare the financial statements in these previous chapters did not necessarily reflect correct amounts. Chapter 3 introduces the concept of adjusting entries and how these satisfy the matching principle, ensuring revenues and expenses are reported in the correct accounting period. The preparation of an adjusted trial balance is discussed, as well as its use in completing financial statements. At the end of the accounting period, after financial statements have been prepared, it is necessary to close temporary accounts to retained earnings. This process is introduced in this chapter, as is the preparation of a post-closing trial balance. The accounting cycle, the steps performed each accounting period that result in financial statements, is also reviewed.

    Chapter 3 Learning Objectives

    • LO1 – Explain how the timeliness, matching, and recognition GAAP require the recording of adjusting entries.

    • LO2 – Explain the use of and prepare the adjusting entries required for prepaid expenses, depreciation, unearned revenues, accrued revenues, and accrued expenses.

    • LO3 – Prepare an adjusted trial balance and explain its use.

    • LO4 – Use an adjusted trial balance to prepare financial statements.

    • LO5 – Identify and explain the steps in the accounting cycle.

    • LO6 – Explain the use of and prepare closing entries and a post-closing trial balance.

    Concept Self-Check

    Use the following as a self-check while working through Chapter 3.

    1. What is the GAAP principle of timeliness?

    2. What is the GAAP principle of matching?

    3. What is the GAAP principle of revenue recognition?

    4. What are adjusting entries and when are they journalized?

    5. What are the five types of adjustments?

    6. Why is an adjusted trial balance prepared?

    7. How is the unadjusted trial balance different from the adjusted trial balance?

    8. What are the four closing entries and why are they journalized?

    9. Why is the Dividends account not closed to the income summary?

    10. When is a post-closing trial balance prepared?

    11. How is a post-closing trial balance different from an adjusted trial balance?

    NOTE: The purpose of these questions is to prepare you for the concepts introduced in the chapter. Your goal should be to answer each of these questions as you read through the chapter. If, when you complete the chapter, you are unable to answer one or more the Concept Self-Check questions, go back through the content to find the answer(s). Solutions are not provided to these questions.

    3.1 The Operating Cycle

    LO1 – Explain how the timeliness, matching, and recognition GAAP require the recording of adjusting entries.

    Financial transactions occur continuously during an accounting period as part of a sequence of operating activities. For Big Dog Carworks Corp., this sequence of operating activities takes the following form:

    1. Operations begin with some cash on hand.

    2. Cash is used to purchase supplies and to pay expenses.

    3. Revenue is earned as repair services are completed for customers.

    4. Cash is collected from customers.

    This cash-to-cash sequence of transactions is commonly referred to as an operating cycle and is illustrated in Figure 3.1.

    img82.png

    Figure 3.1 One Operating Cycle

    Depending on the type of business, an operating cycle can vary in duration from short, such as one week (e.g., a grocery store) to much longer, such as one year (e.g., a car dealership). Therefore, an annual accounting period could involve multiple operating cycles as shown in Figure 3.2.

    img83.png

    Figure 3.2 Operating Cycles Within an Annual Accounting Period

    Notice that not all of the operating cycles in Figure 3.2 are completed within the accounting period. Since financial statements are prepared at specific time intervals to meet the GAAP requirement of timeliness, it is necessary to consider how to record and report transactions related to the accounting period's incomplete operating cycles. Two GAAP requirements — recognition and matching — provide guidance in this area, and are the topic of the next sections.

    Recognition Principle in More Detail

    GAAP provide guidance about when an economic activity should be recognized in financial statements. An economic activity is recognized when it meets two criteria:

    1. it is probable that any future economic benefit associated with the item will flow to the business; and

    2. it has a value that can be measured with reliability.

    Revenue Recognition Illustrated

    Revenue recognition is the process of recording revenue in the accounting period in which it was earned; this is not necessarily when cash is received. Most corporations assume that revenue has been earned at an objectively-determined point in the accounting cycle. For instance, it is often convenient to recognize revenue at the point when a sales invoice has been sent to a customer and the related goods have been received or services performed. This point can occur before receipt of cash from a customer, creating an asset called Accounts Receivable and resulting in the following entry:

    img84.png

    When cash payment is later received, the asset Accounts Receivable is exchanged for the asset Cash and the following entry is made:

    img85.png

    Revenue is recognized in the first entry (the credit to revenue), prior to the receipt of cash. The second entry has no effect on revenue.

    When cash is received at the same time that revenue is recognized, the following entry is made:

    img86.png

    When a cash deposit or advance payment is obtained before revenue is earned, a liability called Unearned Revenue is recorded as follows:

    img87.png

    Revenue is not recognized until the services have been performed. At that time, the following entry is made:

    img88.png

    The preceding entry reduces the unearned revenue account by the amount of revenue earned.

    The matching of revenue to a particular time period, regardless of when cash is received, is an example of accrual accounting. Accrual accounting is the process of recognizing revenues when earned and expenses when incurred regardless of when cash is exchanged; it forms the basis of GAAP. Recognition of expenses is discussed in the next section.

    Expense Recognition Illustrated

    In a business, costs are incurred continuously. To review, a cost is recorded as an asset if it will be incurred in producing revenue in future accounting periods. A cost is recorded as an expense if it will be used or consumed during the current period to earn revenue. This distinction between types of cost outlays is illustrated in Figure 3.3.

    img89.png

    Figure 3.3 The Interrelationship Between Assets and Expense

    In the previous section regarding revenue recognition, journal entries illustrated three scenarios where revenue was recognized before, at the same time as, and after cash was received. Similarly, expenses can be incurred before, at the same time as, or after cash is paid out. An example of when expenses are incurred before cash is paid occurs when the utilities expense for January is not paid until February. In this case, an account payable is created in January as follows:

    img90.png

    The utilities expense is reported in the January income statement.

    When the January utilities are paid in February, the following is recorded:

    img91.png

    The preceding entry has no effect on expenses reported on the February income statement.

    Expenses can also be recorded at the same time that cash is paid. For example, if salaries for January are paid on January 31, the entry on January 31 is:

    img92.png

    As a result of this entry, salaries expense is reported on the January income statement when cash is paid.

    Finally, a cash payment can be made before the expense is incurred, such as insurance paid in advance. A prepayment of insurance creates an asset Prepaid Insurance and is recorded as:

    img93.png

    As the prepaid insurance is used, it is appropriate to report an expense on the income statement by recording the following entry:

    img94.png

    The preceding examples illustrate how to match expenses to the appropriate accounting period. The matching principle requires that expenses be reported in the same period as the revenues they helped generate. That is, expenses are reported on the income statement: a) when related revenue is recognized, or b) during the appropriate time period, regardless of when cash is paid.

    To ensure the recognition and matching of revenues and expenses to the correct accounting period, account balances must be reviewed and adjusted prior to the preparation of financial statements. This is the topic of the next section.

    3.2 Adjusting Entries

    LO2 – Explain the use of and prepare the adjusting entries required for prepaid expenses, depreciation, unearned revenues, accrued revenues, and accrued expenses.

    At the end of an accounting period, before financial statements can be prepared, the accounts must be reviewed for potential adjustments. This review is done by using the unadjusted trial balance. The unadjusted trial balance is a trial balance where the accounts have not yet been adjusted. The trial balance of Big Dog Carworks Corp. at January 31 was prepared in Chapter 2 and appears in Figure 3.4 below. It is an unadjusted trial balance because the accounts have not yet been updated for adjustments. We will use this trial balance to illustrate how adjustments are identified and recorded.

    Big Dog Carworks Corp.
    Unadjusted Trial Balance
    At January 31, 2015
    Acct. Account Debit
     
    Credit
    101 Cash $3,700
    110 Accounts receivable 2,000
    161 Prepaid insurance 2,400
    183 Equipment 3,000
    184 Truck 8,000
    201 Bank loan $6,000
    210 Accounts payable 700
    247 Unearned revenue 400
    320 Share capital 10,000
    330 Dividends 200
    450 Repair revenue 10,000
    654 Rent expense 1,600
    656 Salaries expense 3,500
    668 Supplies expense 2,000
    670 Truck operation expense 700
    $27,100 $27,100

    Figure 3.4 Unadjusted Trial Balance of Big Dog Carworks Corp. at January 31, 2015

    Adjustments are recorded with adjusting entries. The purpose of adjusting entries is to ensure both the balance sheet and the income statement faithfully represent the account balances for the accounting period. Adjusting entries help satisfy the matching principle. There are five types of adjusting entries as shown in Figure 3.5, each of which will be discussed in the following sections.

    img95.png

    Figure 3.5 Five Types of Adjusting Entries

    Adjusting Prepaid Asset Accounts

    An asset or liability account requiring adjustment at the end of an accounting period is referred to as a mixed account because it includes both a balance sheet portion and an income statement portion. The income statement portion must be removed from the account by an adjusting entry.

    Refer to Figure 3.4 which shows an unadjusted balance in prepaid insurance of $2,400. Recall from Chapter 2 that Big Dog paid for a 12-month insurance policy that went into effect on January 1 (transaction 5).

    img96.png

    At January 31, one month or $200 of the policy has expired (been used up) calculated as $2,400/12 months = $200.

    The adjusting entry on January 31 to transfer $200 out of prepaid insurance and into insurance expense is:

    img97.png

    As shown below, the balance remaining in the Prepaid Insurance account is $2,200 after the adjusting entry is posted. The $2,200 balance represents the unexpired asset that will benefit future periods, namely, the 11 months from February to December, 2015. The $200 transferred out of prepaid insurance is posted as a debit to the Insurance Expense account to show how much insurance has been used during January.

    img98.png

    If the adjustment was not recorded, assets on the balance sheet would be overstated by $200 and expenses would be understated by the same amount on the income statement.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Prepaid Expenses.

    Adjusting Unearned Liability Accounts

    On January 15, Big Dog received a $400 cash payment in advance of services being performed: $300 for January and $100 for February.

    img99.png

    This advance payment was originally recorded as unearned, since the cash was received before repair services were performed. At January 31, $300 of the $400 unearned amount has been earned. Therefore, $300 must be transferred from unearned repair revenue into repair revenue. The adjusting entry at January 31 is:

    img100.png

    After posting the adjustment, the $100 remaining balance in unearned repair revenue ($400 – $300) represents the amount at the end of January that will be earned in February.

    img101.png

    If the adjustment was not recorded, unearned repair revenue would be overstated (too high) by $300 causing liabilities on the balance sheet to be overstated. Additionally, revenue would be understated (too low) by $300 on the income statement if the adjustment was not recorded.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Unearned Revenues.

    Adjusting Plant and Equipment Accounts

    Plant and equipment assets, also known as long-lived assets, are expected to help generate revenues over the current and future accounting periods because they are used to produce goods, supply services, or used for administrative purposes. The truck and equipment purchased by Big Dog Carworks Corp. in January are examples of plant and equipment assets that provide economic benefits for more than one accounting period. Because plant and equipment assets are useful for more than one accounting period, their cost must be spread over the time they are used. This is done to satisfy the matching principle. For example, the $100,000 cost of a machine expected to be used over five years is not expensed entirely in the year of purchase because this would cause expenses to be overstated in Year 1 and understated in Years 2, 3, 4, and 5. Therefore, the $100,000 cost must be spread over the asset's five-year life.

    The process of allocating the cost of a plant and equipment asset over the period of time it is expected to be used is called depreciation. The amount of depreciation is calculated using the actual cost and an estimate of the asset's useful life and residual value. The useful life of a plant and equipment asset is an estimate of how long it will actually be used by the business regardless of how long the asset is expected to last. For example, a car might have a manufacturer's suggested life of 10 years but a business may have a policy of keeping cars for only 2 years. The useful life for depreciation purposes would therefore be 2 years and not 10 years. The residual value is an estimate of what the plant and equipment asset will be sold for when it is no longer used by a business. Residual value can be zero. There are different formulas for calculating depreciation. We will use the straight-line method of depreciation:

    img102.png

    The cost less estimated residual value is the total depreciable cost of the asset. The straight-line method allocates the depreciable cost equally over the asset's estimated useful life. When recording depreciation expense, our initial instinct is to debit depreciation expense and credit the Plant and Equipment asset account in the same way prepaids were adjusted with a debit to an expense and a credit to the Prepaid asset account. However, crediting the Plant and Equipment asset account is incorrect. Instead, a contra account called accumulated depreciation must be credited. A contra account is an account that is related to another account and typically has an opposite normal balance that is subtracted from the balance of its related account on the financial statements. Accumulated depreciation records the amount of the asset's cost that has been expensed since it was put into use. Accumulated depreciation has a normal credit balance that is subtracted from a Plant and Equipment asset account on the balance sheet.

    Initially, the concept of crediting Accumulated Depreciation may be confusing because of how we learned to adjust prepaids (debit an expense and credit the prepaid). Remember that prepaids actually get used up and disappear over time. The Plant and Equipment asset account is not credited because, unlike a prepaid, a truck or building does not get used up and disappear. The goal in recording depreciation is to match the cost of the asset to the revenues it helped generate. For example, a $50,000 truck that is expected to be used by a business for 4 years will have its cost spread over 4 years. After 4 years, the asset will likely be sold (journal entries related to the sale of plant and equipment assets are discussed in Chapter 8).

    The adjusting journal entry to record depreciation is:

    img103.png

    Subtracting the accumulated depreciation account balance from the Plant and Equipment asset account balance equals the carrying amount or net book value of the plant and equipment asset that is reported on the balance sheet.

    Let's work through two examples to demonstrate depreciation adjustments. Big Dog Carworks Corp.'s January 31, 2015 unadjusted trial balance showed the following two plant and equipment assets:

    Big Dog Carworks Corp.
    Unadjusted Trial Balance
    At January 31, 2015
    Acct. Account Debit
     
    Credit
    183 Equipment 3,000
    184 Truck 8,000

    The equipment was purchased for $3,000.

    img104.png

    The equipment was recorded as a plant and equipment asset because it has an estimated useful life greater than 1 year. Assume its actual useful life is 10 years (120 months) and the equipment is estimated to be worth $0 at the end of its useful life (residual value of $0).

    img105.png

    Note that depreciation is always rounded to the nearest whole dollar. This is because depreciation is based on estimates — an estimated residual value and an estimated useful life; it is not exact. The following adjusting journal entry is made on January 31:

    img106.png

    When the adjusting entry is posted, the accounts appear as follows:

    img107.png

    For financial statement reporting, the asset and contra asset accounts are combined. The net book value of the equipment on the balance sheet is shown as $2,975 ($3,000 – $25).

    BDCC also shows a truck for $8,000 on the January 31, 2015 unadjusted trial balance.

    img108.png

    Assume the truck has an estimated useful life of 80 months and a zero estimated residual value. At January 31, one month of the truck cost has expired since it was put into operation in January. Using the straight-line method, depreciation is calculated as:

    img109.png

    The adjusting entry recorded on January 31 is:

    img110.png

    When the adjusting entry is posted, the accounts appear as follows:

    img111.png

    For financial statement reporting, the asset and contra asset accounts are combined. The net book value of the truck on the balance sheet is shown as $7,900 ($8,000 – $100).

    If depreciation adjustments are not recorded, assets on the balance sheet would be overstated. Additionally, expenses would be understated on the income statement causing net income to be overstated. If net income is overstated, retained earnings on the balance sheet would also be overstated.

    It is important to note that land is a long-lived asset. However, it is not depreciated because it does not get used up over time. Therefore, land is often referred to as a non-depreciable asset.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Depreciation.

    Adjusting for Accrued Revenues

    Accrued revenues are revenues that have been earned but not yet collected or recorded. For example, a bank has numerous notes receivable. Interest is earned on the notes receivable as time passes. At the end of an accounting period, there would be notes receivable where the interest has been earned but not collected or recorded. The adjusting entry for accrued revenues is:

    img112.png

    For Big Dog Carworks Corp., assume that on January 31, $400 of repair work was completed for a client but it had not yet been collected or recorded. BDCC must record the following adjusting entry:

    img113.png

    img114.png

    If the adjustment was not recorded, assets on the balance sheet would be understated by $400 and revenues would be understated by the same amount on the income statement.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Accrued Revenues.

    Adjusting for Accrued Expenses

    Accrued expenses are expenses that have been incurred but not yet paid or recorded. For example, a utility bill received at the end of the accounting period is likely not payable for 2–3 weeks. Utilities for the period have been used but have not yet been paid or recorded. The adjusting entry for accrued expenses is:

    img115.png

    Accruing Interest Expense

    For Big Dog Carworks Corp., the January 31, 2015 unadjusted trial balance shows a $6,000 bank loan balance. Assume it is a 4%, 60-day bank loan1. It was dated January 3 which means that on January 31, 28 days of interest have accrued (January 31 less January 3 = 28 days) as shown in Figure 3.6.

    img116.png

    Figure 3.6 Interest Incurred During an Accounting Period

    The formula for calculating interest when the term is expressed in days is:

    img117.png

    The interest expense accrued at January 31 is calculated as:

    img118.png

    Interest is normally expressed as an annual rate. Therefore, the 28 days must be divided by the 365 days in a year. Normally all interest calculations in this textbook are rounded to two decimal places. However, for simplicity of demonstrations in this chapter, we will round to the nearest whole dollar.

    BDCC's adjusting entry on January 31 is:

    img119.png

    This adjusting entry enables BDCC to include the interest expense on the January income statement even though the payment has not yet been made. The entry creates a payable that will be reported as a liability on the balance sheet at January 31.

    When the adjusting entry is posted, the accounts appear as:

    img120.png

    On February 28, interest will again be accrued and recorded as:

    img121.png

    On March 4 when the bank loan matures, Big Dog will pay the interest and principal and record the following entry:

    img122.png

    The $36 debit to interest payable will cause the Interest Payable account to go to zero since the liability no longer exists once the cash is paid. Notice that the total interest expense recorded on the bank loan was img123.png expensed in January, $18 expensed in February, and $3 expensed in March. The interest expense was matched to the life of the bank loan.

    Accruing Income Tax Expense

    Another adjustment that is required for Big Dog Carworks Corp. involves the recording of corporate income taxes. In most jurisdictions, a corporation is taxed as an entity separate from its shareholders. For simplicity, assume BDCC's income tax due for January 2015 is $500. The adjusting entry is at January 31:

    img124.png

    When the adjusting entry is posted, the accounts appear as follows:

    img125.png

    The above adjusting entry enables the company to match the income tax expense accrued in January to the income earned during the same month.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Accrued Expenses.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Collection/Payment of Accrual Adjustments in the Next Accounting Period.

    The five types of adjustments discussed in the previous paragraphs are summarized in Figure 3.7.

    img126.png

    Figure 3.7 Summary of the Five Types of Adjusting Entries

    3.3 The Adjusted Trial Balance

    LO3 – Prepare an adjusted trial balance and explain its use.

    In the last section, adjusting entries were recorded and posted. As a result, some account balances reported on the January 31, 2015 unadjusted trial balance in Figure 2 have changed. Recall that an unadjusted trial balance reports account balances before adjusting entries have been recorded and posted. An adjusted trial balance reports account balances after adjusting entries have been recorded and posted. Figure 3.8 shows the adjusted trial balance for BDCC at January 31, 2015.

    In Chapters 1 and 2, the preparation of financial statements was demonstrated using BDCC's unadjusted trial balance. We now know that an adjusted trial balance must be used to prepare financial statements.

    Big Dog Carworks Corp.
    Adjusted Trial Balance
    At January 31, 2015
    Account Balance
    Account Debit Credit
    Cash $3,700
    Accounts receivable 2,400
    Prepaid insurance 2,200
    Equipment 3,000
    Accumulated depreciation – equipment $     25
    Truck 8,000
    Accumulated depreciation – truck 100
    Bank loan 6,000
    Accounts payable 700
    Interest payable 18
    Unearned repair revenue 100
    Income tax payable 500
    Share capital 10,000
    Dividends 200
    Repair revenue 10,700
    Depreciation expense – equipment 25
    Depreciation expense – truck 100
    Rent expense 1,600
    Insurance expense 200
    Interest expense 18
    Salaries expense 3,500
    Supplies expense 2,000
    Truck operation expense 700
    Income tax expense 500
     
    Total debits and credits
    $28,143 $28,143

    Figure 3.8 BDCC's January 31, 2015 Adjusted Trial Balance

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Adjusted Trial Balance.

    3.4 Using the Adjusted Trial Balance to Prepare Financial Statements

    LO4 – Use an adjusted trial balance to prepare financial statements.

    In the last section, we saw that the adjusted trial balance is prepared after journalizing and posting the adjusting entries. This section shows how financial statements are prepared using the adjusted trial balance.

    img127.png

    Figure 3.9 BDCC's January 31, 2015 Adjusted Trial Balance and Links Among Financial Statements

    The income statement is prepared first, followed by the statement of changes in equity as shown below.

    img128.png

    The balance sheet can be prepared once the statement of changes in equity is complete.

    img129.png

    Notice how accumulated depreciation is shown on the balance sheet.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Adjustments and Financial Statements.

    3.5 The Accounting Cycle

    LO5 – Identify and explain the steps in the accounting cycle.

    The concept of the accounting cycle was introduced in Chapter 2. The accounting cycle consists of the steps followed each accounting period to prepare financial statements. These eight steps are:

    Step 1: Transactions are analyzed and recorded in the general journal

    Step 2: The journal entries in the general journal are posted to accounts in the general ledger

    Step 3: An unadjusted trial balance is prepared to ensure total debits equal total credits

    Step 4: The unadjusted account balances are analyzed and adjusting entries are journalized in the general journal and posted to the general ledger

    Step 5: An adjusted trial balance is prepared to prove the equality of debits and credits

    Step 6: The adjusted trial balance is used to prepare financial statements

    Step 7: Closing entries are journalized and posted

    Step 8: Prepare a post-closing trial balance

    Steps 1 through 6 were introduced in this and the preceding chapters. Steps 7 and 8 are discussed in the next section.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Reviewing the Accounting Cycle.

    3.6 The Closing Process

    LO6 – Explain the use of and prepare closing entries and a post-closing trial balance.

    At the end of a fiscal year, after financial statements have been prepared, the revenue, expense, and dividend account balances must be zeroed so that they can begin to accumulate amounts belonging to the new fiscal year. To accomplish this, closing entries are journalized and posted. Closing entries transfer each revenue and expense account balance, as well as any balance in the Dividend account, into retained earnings. Revenues, expenses, and dividends are therefore referred to as temporary accounts because their balances are zeroed at the end of each accounting period. Balance sheet accounts, such as retained earnings, are permanent accounts because they have a continuing balance from one fiscal year to the next. The closing process transfers temporary account balances into a permanent account, namely retained earnings. The four entries in the closing process are detailed below.

    Entry 1: Close the revenue accounts to the income summary account

    A single compound closing entry is used to transfer revenue account balances to the income summary account. The income summary is a checkpoint: once all revenue and expense account balances are transferred/closed to the income summary, the balance in the Income Summary account must be equal to the net income/loss reported on the income statement. If not, the revenues and expenses were not closed correctly.

    Entry 2: Close the expense accounts to the Income Summary account

    The expense accounts are closed in one compound closing journal entry to the Income Summary account. All expense accounts with a debit balance are credited to bring them to zero. Their balances are transferred to the Income Summary account as an offsetting debit.

    After entries 1 and 2 above are posted to the Income Summary account, the balance in the income summary must be compared to the net income/loss reported on the income statement. If the income summary balance does not match the net income/loss reported on the income statement, the revenues and/or expenses were not closed correctly.

    Entry 3: Close the income summary to retained earnings

    The Income Summary account is closed to the Retained Earnings account. This procedure transfers the balance in the income summary to retained earnings. Again, the amount closed from the income summary to retained earnings must always equal the net income/loss as reported on the income statement.

    Note that the Dividend account is not closed to the Income Summary account because dividends is not an income statement account. The dividend account is closed in Entry 4.

    Entry 4: Close dividends to retained earnings

    The Dividend account is closed to the Retained Earnings account. This results in transferring the balance in dividends, a temporary account, to retained earnings, a permanent account.

    The balance in the Income Summary account is transferred to retained earnings because the net income (or net loss) belongs to the shareholders. The closing entries for Big Dog Carworks Corp. are shown in Figure 3.10.

    img130.png

    Figure 3.10 Closing Entries

    Posting the Closing Entries to the General Ledger

    When entries 1 and 2 are posted to the general ledger, the balances in all revenue and expense accounts are transferred to the Income Summary account. The transfer of these balances is shown in Figure 3.11. Notice that a zero balance results for each revenue and expense account after the closing entries are posted, and there is a $2,057 credit balance in the income summary. The income summary balance agrees to the net income reported on the income statement.

    img131.png

    Figure 3.11 Closing Revenue and Expense Accounts

    When the income summary is closed to retained earnings in the third closing entry, the $2,057 credit balance in the income summary account is transferred into retained earnings as shown in Figure 3.12. As a result, the income summary is left with a zero balance.

    img132.png

    Figure 3.12 Closing the Income Summary Account

    This example demonstrated closing entries when there was a net income. When there is a net loss, the Income Summary account will have a debit balance after revenues and expenses have been closed. To close the Income Summary account when there is a net loss, the following closing entry is required:

    img133.png

    Finally, when dividends is closed to retained earnings in the fourth closing entry, the $200 debit balance in the Dividends account is transferred into retained earnings as shown in Figure 3.13. After the closing entry is posted, the Dividends account is left with a zero balance and retained earnings is left with a credit balance of $1,857. Notice that the $1,857 must agree to the retained earnings balance calculated on the statement of changes in equity.

    img134.png

    Figure 3.13 Closing the Dividends Account

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Closing Entries.

    The Post–Closing Trial Balance

    A post-closing trial balance is prepared immediately following the posting of closing entries. The purpose is to ensure that the debits and credits in the general ledger are equal and that all temporary accounts have been closed. The post-closing trial balance for Big Dog Carworks Corp. appears below.

    img135.png

    Note that only balance sheet accounts, the permanent accounts, have balances and are carried forward to the next accounting year. All temporary accounts begin the new fiscal year with a zero balance, so they can be used to accumulate amounts belonging to the new time period.

    icon-exploration2.png An exploration is available on the Lyryx system. Log into your Lyryx course to run Closing Errors.

    Summary of Chapter 3 Learning Objectives

    LO1 – Explain how the timeliness, matching, and recognition GAAP require the recording of adjusting entries.

    Financial statements must be prepared in a timely manner, at minimum, once per fiscal year. For statements to reflect activities accurately, revenues and expenses must be recognized and reported in the appropriate accounting period. In order to achieve this type of matching, adjusting entries need to be prepared.

    LO2 – Explain the use of and prepare the adjusting entries required for prepaid expenses, depreciation, unearned revenues, accrued revenues, and accrued expenses.

    Adjusting entries are prepared at the end of an accounting period. They allocate revenues and expenses to the appropriate accounting period regardless of when cash was received/paid. The five types of adjustments are:

    img136.png

    LO3 – Prepare an adjusted trial balance and explain its use.

    The adjusted trial balance is prepared using the account balances in the general ledger after adjusting entries have been posted. Debits must equal credits. The adjusted trial balance is used to prepare the financial statements.

    LO4 – Use an adjusted trial balance to prepare financial statements.

    Financial statements are prepared based on adjusted account balances.

    LO5 – Identify and explain the steps in the accounting cycle.

    The steps in the accounting cycle are followed each accounting period in the recording and reporting of financial transactions. The steps are:

    1. Transactions are analyzed and recorded in the general journal.

    2. The journal entries in the general journal are posted to accounts in the general ledger.

    3. An unadjusted trial balance is prepared to ensure total debits equal total credits.

    4. The unadjusted account balances are analyzed, and adjusting entries are journalized in the general journal and posted to the general ledger.

    5. An adjusted trial balance is prepared to prove the equality of debits and credits.

    6. The adjusted trial balance is used to prepare financial statements.

    7. Closing entries are journalized and posted.

    8. Prepare a post-closing trial balance.

    LO6 – Explain the use of and prepare closing entries and a post-closing trial balance.

    After the financial statements have been prepared, the temporary account balances (revenues, expenses, and dividends) are transferred to retained earnings, a permanent account, via closing entries. The result is that the temporary accounts will have a zero balance and will be ready to accumulate transactions for the next accounting period. The four closing entries are:

    img137.png

    The post-closing trial balance is prepared after the closing entries have been posted to the general ledger. The post-closing trial balance will contain only permanent accounts because all the temporary accounts have been closed.

    Discussion Questions

    1. Explain the sequence of financial transactions that occur continuously during an accounting time period. What is this sequence of activities called?

    2. Do you have to wait until the operating cycle is complete before you can measure income using the accrual basis of accounting?

    3. What is the relationship between the matching concept and accrual accounting? Are revenues matched to expenses, or are expenses matched to revenues? Does it matter one way or the other?

    4. What is the impact of the going concern concept on accrual accounting?

    5. Identify three different categories of expenses.

    6. What are adjusting entries and why are they required?

    7. Why are asset accounts like Prepaid Insurance adjusted? How are they adjusted?

    8. How are plant and equipment asset accounts adjusted? Is the procedure similar to the adjustment of other asset and liability accounts at the end of an accounting period?

    9. What is a contra account and why is it used?

    10. How are liability accounts like Unearned Repair Revenue adjusted?

    11. Explain the term accruals. Give examples of items that accrue.

    12. Why is an adjusted trial balance prepared?

    13. How is the adjusted trial balance used to prepare financial statements?

    14. List the eight steps in the accounting cycle.

    15. Which steps in the accounting cycle occur continuously throughout the accounting period?

    16. Which steps in the accounting cycle occur only at the end of the accounting period? Explain how they differ from the other steps.

    17. Give examples of revenue, expense, asset, and liability adjustments.

    18. In general, income statement accounts accumulate amounts for a time period not exceeding one year. Why is this done?

    19. Identify which types of general ledger accounts are temporary and which are permanent.

    20. What is the income summary account and what is its purpose?

    21. What is a post-closing trial balance and why is it prepared?

    Exercises

    EXERCISE 3–1 (LO1,2) Adjusting Entries

    The following are account balances of Graham Corporation:

    Account Title Amount in Balance
    Unadjusted after
    Trial Balance Adjustment
    Interest Receivable
     
    $
     
    -0-
    $110
    Prepaid Insurance 1,800 600
    Interest Payable -0- 90
    Salaries Payable -0- 450
    Unearned Rent 700 200

    Required:

    1. Enter the unadjusted balance for each account in the following T-accounts: Interest Receivable, Prepaid Insurance, Interest Payable, Salaries Payable, Unearned Rent, Interest Earned, Rent Earned, Insurance Expense, Interest Expense, and Salaries Expense.

    2. Reconstruct the adjusting entry that must have been recorded for each account.

    3. Post these adjusting entries and agree ending balances in each T-account to the adjusted balances above.

    4. List revenue and expense amounts for the period.

    EXERCISE 3–2 (LO1,2) Adjusting Entries

    The trial balance of Lauer Corporation at December 31, 2015 follows, before and after the posting of adjusting entries.

    Trial Balance Adjustments Adjusted
    Trial Balance
    Dr. Cr. Dr. Cr. Dr. Cr.
    Cash $4,000 $4,000
    Accounts Receivable 5,000 5,000
    Prepaid Insurance 3,600 3,300
    Prepaid Rent 1,000 500
    Truck 6,000 6,000
    Accumulated Depreciation
     
    $
     
    -0-
    $1,500
    Accounts Payable 7,000 7,400
    Salaries Payable 1,000
    Unearned Rent 1,200 600
    Share Capital 2,700 2,700
    Revenue 25,000 25,000
    Rent Earned 600
    Advertising Expense 700 700
    Commissions Expense 2,000 2,000
    Depreciation Expense 1,500
    Insurance Expense 300
    Interest Expense 100 500
    Rent Expense 5,500 6,000
    Salaries Expense 8,000 9,000
     
    Totals
    $35,900 $35,900 $38,800 $38,800

    Required:

    1. Indicate in the "Adjustments" column the debit or credit difference between the unadjusted trial balance and the adjusted trial balance.

    2. Prepare in general journal format the adjusting entries that have been recorded. Include descriptions.

    EXERCISE 3–3 (LO1,2) Adjusting Entries

    The following data are taken from an unadjusted trial balance at December 31, 2015:

    Prepaid Rent $
     
    600
    Office Supplies 700
    Income Taxes Payable -0-
    Unearned Commissions
     
    1,500
    Salaries Expense 5,000

    Additional Information:

    1. The prepaid rent consisted of a payment for three months' rent at $200 per month for December 2015, January 2016, and February 2016.

    2. Office supplies on hand at December 31, 2015 amounted to $300.

    3. The estimated income taxes for 2015 are $5,000.

    4. All but $500 in the Unearned Commissions account has been earned in 2015.

    5. Salaries for the last three days of December amounting to $300 have not yet been recorded.

    Required:

    1. Prepare all necessary adjusting entries in general journal format.

    2. Calculate the cumulative financial impact on assets, liabilities, equity, revenue and expense if these adjusting entries are not made.

    EXERCISE 3–4 (LO1,2) Adjusting Entries

    The following are general ledger accounts extracted from the records of Bernard Inc. at December 31, 2015, its year-end ('Bal' = unadjusted balance):

    Prepaid Advertising Accounts Payable Share Capital
    Bal. 1,000 500 Bal. 15,000 Bal. 8,000
     
    200
     
     
    100 Subscription Revenue
    Unused Supplies 400 5,000
    Bal. 750 400 800
     
     
     
    Advertising Expense
     
    Salaries Payable 500
    Equipment 700
     
    Bal. 21,750
     
     
     
    Unearned Subscriptions Commissions Expense
    Acc. Dep'n – Equipment
     
    5,000 Bal. 10,000 800
    Bal. 1,500
     
     
    250
     
    Dep'n Expense – Equipment
     
     
    250
     
     
     
     
     
    Maintenance Expense
     
     
    200
     
     
     
     
     
    Salaries Expense
     
     
    Bal. 9,500
     
     
    700
     
     
     
     
     
    Supplies Expense
     
     
    Bal. 2,500
     
     
    400
     
     
     
     
     
    Telephone Expense
     
     
    100
     
     
     
     
     
    Utilities Expense
     
     
    400

    Required: Prepare in general journal format the adjusting entries that were posted. Include plausible descriptions/narratives for each adjustment.

    EXERCISE 3–5 (LO1,2) Adjusting Entries

    The following unadjusted accounts are extracted from the general ledger of A Corp. at December 31, 2015:

    Truck Depreciation Expense – Truck Acc. Dep'n – Truck
     
    10,000
     
     
     
    1,300
     
     
     
     
     
    1,300

    Additional Information: The truck was purchased January 1, 2015. It has an estimated useful life of 4 years.

    Required: Prepare the needed adjusting entry at December 31, 2015.

    EXERCISE 3–6 (LO1,2) Adjusting Entries

    The following unadjusted accounts are taken from the records of B Corp. at December 31, 2015:

    Bank Loan Interest Expense Interest Payable
     
     
     
    12,000
     
    1,100
     
     
     
     
     
    100

    Additional Information: The bank loan was received on January 1, 2015. It bears interest at 10 per cent.

    Required: Prepare the adjusting entry at December 31, 2015.

    EXERCISE 3–7 (LO1,2) Adjusting Entries

    The following general ledger accounts and additional information are taken from the records of Wolfe Corporation at the end of its fiscal year, December 31, 2015.

    Cash 101 Unused Supplies 173 Advertising Exp. 610
    Bal. 2,700
     
     
    Bal. 700
     
     
    Bal. 200
     
     
     
    Accounts Receivable 110 Share Capital 320 Salaries Expense 656
    Bal. 2,000
     
     
    Bal. 3,800 Bal. 4,500
     
    Prepaid Insurance 161 Repair Revenue 450 Telephone Expense 669
    Bal. 1,200 Bal. 7,750 Bal. 250

    Additional Information:

    1. The prepaid insurance is for a one-year policy, effective July 1, 2015.

    2. A physical count indicated that $500 of supplies is still on hand.

    3. A $50 December telephone bill has been received but not yet recorded.

    Required: Record all necessary adjusting entries in general journal format.

    EXERCISE 3–8 (LO2) Adjusting Entries

    Below are descriptions of various monthly adjusting entries:

    1. Adjusting entry for revenue earned but not yet billed to the customer.

    2. Adjusting entry for cash received from a customer for revenue not yet earned.

    3. Adjusting entry for revenue earned that was originally received as cash in advance in the previous month.

    4. Adjusting entry for services received from a supplier, but not yet paid.

    5. Adjusting entry for cash paid to a supplier for repair services not yet received.

    6. Adjusting entry for repair services received that was originally paid as cash in advance to the supplier in the previous month.

    7. Adjusting entry for salaries earned by employees, but not yet paid.

    8. Adjusting entry for annual depreciation expense for equipment.

    Required: For each description above, identify the likely journal entry debit and credit account.

    EXERCISE 3–9 (LO2) Adjusting Entries

    Turner Empire Co. employs 65 employees. The employees are paid every Monday for work done from the previous Monday to the end-of-business on Friday, or a 5-day work week. Each employee earns $80 per day.

    Required:

    1. Calculate the total weekly payroll cost and the salary adjustment at March 31, 2016.

    2. Prepare the adjusting entry at March 31, 2016.

    3. Prepare the subsequent cash entry on April 4, 2016.

    EXERCISE 3–10 (LO1,2,3) Adjusting Entries

    Below is a trial balance for Quertin Quick Fix Ltd. at October 31, 2016 with three sets of debit/credit columns. The first set is before the October month-end adjusting entries, and the third column is after the October month-end adjusting entries.

    Quertin Quick Fix Ltd.
    Trial Balance
    At October 31, 2016
    Unadjusted Trial Balance Adjustments Adjusted Trial Balance
    Debit Credit Debit Credit Debit Credit
    Accounts payable $ 225,000 $ 225,500
    Accounts receivable $ 325,000 $ 395,000
    Accrued salaries payable 5,000 9,500
    Accumulated depreciation, equipment 1,500 2,500
    Advertising expense 1,500 1,500
    Cash 80,000 118,700
    Depreciation expense 800 1,800
    Equipment 150,000 150,000
    Land 150,000 150,000
    Maintenance service expenses 1,000 1,000
    Notes payable 210,000 210,000
    Office supplies 5,000 5,000
    Prepaid advertising expenses 15,000 16,300
    Rent expense 14,000 14,000
    Retained earnings 37,800 37,800
    Salaries expense 45,000 49,500
    Service revenue 300,000 370,000
    Share capital 10,000 10,000
    Unearned service revenue 10,000 50,000
    Utilities expense 12,000 12,500
    $ 799,300 $ 799,300 $ 915,300 $ 915,300

    Required: Determine the differences for all the account balances and identify the most likely adjusting entries that would have been recorded in October to correspond to these differences.

    EXERCISE 3–11 (LO3) Prepare an Adjusted Trial Balance

    After Bernard Inc. completed its first year of operations on December 31, 2015, the following adjusted account balances appeared in the general ledger.

    Prepaid Advertising Accounts Payable Share Capital
     
    1,000
     
     
     
     
     
    13,250
     
     
     
    8,000
     
    Supplies
     
    Subscription Revenue
    750
     
    5,000
     
    Equipment Salaries Payable Advertising Expense
    21,750 700 500
     
    Acc. Dep'n – Equipment Unearned Subscriptions Commissions Expense
    1,500 10,000 800
     
     
     
    Dep'n Expense – Equipment
     
     
    250
     
     
     
    Maintenance Expense
     
     
    200
     
     
     
    Salaries Expense
     
     
    10,200
     
     
     
    Supplies Expense
     
     
    2,500
     
     
     
    Telephone Expense
     
     
    100
     
     
     
    Utilities Expense
     
     
    400

    Required:Prepare an adjusted trial balance at December 31, 2015.

    EXERCISE 3–12 (LO6) Closing Entries

    Below is the adjusted trial balance for Quefort Ltd. as at September 30, 2016:

     
    Debit
     
    Credit
    Accounts payable $ 23,250
    Accounts receivable $ 106,800
    Accrued salaries payable 8,700
    Accumulated depreciation, building 200
    Accumulated depreciation, equipment 3,200
    Advertising expense 4,050
    Building 111,000
    Cash 87,300
    Cash dividends 5,000
    Depreciation expense 2,380
    Equipment 15,000
    Income tax expense 4,500
    Income taxes payable 4,500
    Insurance expense 3,700
    Interest expense 150
    Interest payable 150
    Repair expense 7,800
    Notes payable 30,000
    Office supplies 1,800
    Prepaid insurance expense 12,790
    Rent expense 22,500
    Retained earnings 65,470
    Salaries expense 41,700
    Service revenue 276,000
    Share capital 1,500
    Shop supplies expense 750
    Unearned service revenue 37,500
    Utilities expense 23,250
    $ 450,470 $ 450,470

    Required: Prepare the closing entries.

    EXERCISE 3–13 (LO6) Prepare Closing Entries and a Post-Closing Trial Balance

    The following alphabetized adjusted trial balance information is available for Willis Inc. at December 31, 2015. Assume all accounts have normal balances.

    Accounts Payable $
     
    4,400
    Accounts Receivable 3,600
    Accumulated Depreciation – Machinery
     
    2,800
    Accumulated Depreciation – Warehouse 8,000
    Bank Loan 47,600
    Cash 12,000
    Commissions Earned 20,000
    Depreciation Expense – Machinery 900
    Depreciation Expense – Warehouse 1,200
    Dividends 14,000
    Insurance Expense 1,800
    Interest Expense 2,365
    Interest Payable 1,200
    Land 15,000
    Machinery 20,000
    Retained Earnings 36,000
    Salaries Expense 33,475
    Salaries Payable 1,970
    Share Capital 52,100
    Subscriptions Revenue 17,630
    Supplies 2,500
    Supplies Expense 15,800
    Unearned Fees 800
    Utilities Expense 2,860
    Warehouse 67,000

    Required: Prepare closing entries and a post-closing trial balance.

    Problems

    PROBLEM 3–1 (LO1,2) Adjusting Entries

    The following unrelated accounts are extracted from the records of Meekins Limited at December 31, its fiscal year-end:

    Balance
    Unadjusted Adjusted
    (a) Prepaid Rent $
     
    900
    $
     
    600
    (b) Wages Payable 500 700
    (c) Income Taxes Payable -0- 1,000
    (d) Unearned Commissions Revenue 4,000 3,000
    (e) Other Unearned Revenue 25,000 20,000
    (f) Advertising Expense 5,000 3,500
    (g) Depreciation Expense – Equipment
     
    -0- 500
    (h) Supplies Expense 850 625
    (i) Truck Operation Expense 4,000 4,500

    Required: For each of the above unrelated accounts, prepare the most likely adjusting entry including plausible description/narrative.

    PROBLEM 3–2 (LO1,2) Adjusting Entries Watch Video

    The unadjusted trial balance of Lukas Films Corporation includes the following account balances at December 31, 2015, its fiscal year-end. Assume all accounts have normal debit or credit balances as applicable.

    Prepaid Rent $
     
    1,500
    Unused Supplies -0-
    Equipment 2,400
    Unearned Advertising Revenue
     
    1,000
    Insurance Expense 900
    Supplies Expense 600
    Telephone Expense 825
    Wages Expense 15,000

    The following information applies at December 31:

    1. A physical count of supplies indicates that $100 of supplies have not yet been used at December 31.

    2. A $75 telephone bill for December has been received but not recorded.

    3. One day of wages amounting to $125 remains unpaid and unrecorded at December 31; the amount will be included with the first Friday payment in January.

    4. The equipment was purchased December 1; it is expected to last 2 years. No depreciation has yet been recorded.

    5. The prepaid rent is for three months: December 2015, January 2016, and February 2016.

    6. Half of the unearned advertising has been earned at December 31.

    7. The $900 balance in Insurance Expense is for a one-year policy, effective August 1, 2015.

    Required: Prepare all necessary adjusting entries at December 31, 2015. Descriptions are not needed.

    PROBLEM 3–3 (LO1,2) Adjusting Entries

    The unadjusted trial balance of Mighty Fine Services Inc. includes the following account balances at December 31, 2015, its fiscal year-end. No adjustments have been recorded. Assume all accounts have normal debit or credit balances.

    Notes Receivable $10,000
    Prepaid Rent -0-
    Prepaid Insurance 600
    Unused Supplies 500
    Bank Loan 5,000
    Subscription Revenue 9,000
    Rent Expense 3,900
    Truck Operation Expense
     
    4,000

    The following information applies to the fiscal year-end:

    1. Accrued interest of $250 has not yet been recorded on the Notes Receivable.

    2. The $600 prepaid insurance is for a one-year policy, effective September 1, 2015.

    3. A physical count indicates that $300 of supplies is still on hand at December 31.

    4. Interest on the bank loan is paid on the fifteenth day of each month; the unrecorded interest for the last 15 days of December amounts to $25.

    5. The Subscription Revenue account consists of one $9,000 cash receipt for a 6-month subscription to the corporation's Computer Trends report; the subscription period began December 1, 2015.

    6. Three days of salary amounting to $300 remain unpaid and unrecorded at December 31.

    7. The rent expense account should reflect 12 months of rent. The monthly rent expense is $300.

    8. A bill for December truck operation expense has not yet been received; an amount of $400 is owed.

    Required: Prepare all necessary adjusting entries at December 31, 2015. Descriptions are not needed.

    PROBLEM 3–4 (LO1,2) Adjusting Entries

    The following accounts are taken from the records of Bill Pitt Corp. at the end of its first 12 months of operations ended December 31, 2015, prior to any adjustments.

    In addition to the balances in each set of accounts, additional data are provided for adjustment purposes if applicable. Treat each set of accounts independently of the others.

    1.  
      Depreciation
       
      Truck Expense – Truck Acc. Dep'n – Truck
       
      6,000
       
       
       
      600
       
       
       
       
       
      600

      Additional information: The truck was purchased July 1; it has an estimated useful life of 4 years.

    2. Cash Unearned Rent Rent Earned
       
      600
       
       
       
       
       
      -0-
       
       
       
      600

      Additional information: A part of the office was sublet during the entire 12 months for $50 per month.

    3. Unused Supplies Supplies Expense
       
       
       
       
       
      1,250
       
       

      Additional information: A physical inventory indicated $300 of supplies still on hand at December 31.

    4. Prepaid Rent Rent Expense
       
      1,200
       
       
       
      4,400
       
       

      Additional information: The monthly rent is $400.

    5. Wages Expense Wages Payable
       
      6,000
       
       
       
       
       
      -0-

      Additional information: Unrecorded wages at December 31 amount to $250.

    6. Bank Loan Interest Expense Interest Payable
       
       
       
      8,000
       
      600
       
       
       
       
       
      100

      Additional information: The bank loan bears interest at 10 per cent. The money was borrowed on January 1, 2015.

    7. Cash Utilities Expense Utilities Payable
       
       
       
      1,000
       
      1,200
       
       
       
       
       
      200

      Additional information: The December bill has not yet been received or any accrual made; the amount owing at December 31 is estimated to be another $150.

    8. Cash Prepaid Insurance Insurance Expense
       
       
       
      1,200
       
      600
       
       
       
      600
       
       

      Additional information: A $1,200 one-year insurance policy had been purchased effective February 1, 2015; there is no other insurance policy in effect.

    9. Unearned Rent Revenue Rent Earned
       
       
       
      900
       
       
       
      -0-

      Additional information: The Unearned Rent Revenue balance applies to three months: November 2015, December 2015, and January 2016. $600 of the $900 has been earned as at December 31, 2015.

    10. Cash Other Unearned Revenue Commissions Earned
       
      25,200
       
       
       
       
       
      -0-
       
       
       
      25,200

      Additional information: $2,000 of the total $25,200 balance in commission revenue has not been earned at December 31, 2015.

    Required: Prepare all necessary adjusting entries. Include descriptions/narratives.

    PROBLEM 3–5 (LO1,2,3) Adjusting Accounts

    Roth Contractors Corporation was incorporated on December 1, 2015 and had the following transactions during December:

    Part A

    1. Issued share capital for $5,000 cash.

    2. Paid $1,200 for three months' rent: December 2015; January and February 2016.

    3. Purchased a used truck for $10,000 on credit (recorded as an account payable).

    4. Purchased $1,000 of supplies on credit. These are expected to be used during the month (recorded as expense).

    5. Paid $1,800 for a one-year truck insurance policy, effective December 1.

    6. Billed a customer $4,500 for work completed to date.

    7. Collected $800 for work completed to date.

    8. Paid the following expenses: advertising, $350; interest, $100; telephone, $75; truck operation, $425; wages, $2,500.

    9. Collected $2,000 of the amount billed in (f) above.

    10. Billed customers $6,500 for work completed to date.

    11. Signed a $9,000 contract for work to be performed in January.

    12. Paid the following expenses: advertising, $200; interest, $150; truck operation, $375; wages, $2,500.

    13. Collected a $2,000 advance on work to be done in January (the policy of the corporation is to record such advances as revenue at the time they are received).

    14. Received a bill for $100 for electricity used during the month (recorded as utilities expense).

    Required:

    1. Open general ledger T-accounts for the following: Cash (101), Accounts Receivable (110), Prepaid Insurance (161), Prepaid Rent (162), Truck (184), Accounts Payable (210), Share Capital (320), Repair Revenue (450), Advertising Expense (610), Interest Expense (632), Supplies Expense (668), Telephone Expense (669), Truck Operation Expense (670), Utilities Expense (676), and Wages Expense (677).

    2. Prepare journal entries to record the December transactions. Descriptions are not needed.

    3. Post the entries to general ledger T-accounts.

    Part B

    At December 31, the following information is made available for the preparation of adjusting entries.

    1. One month of the Prepaid Insurance has expired.

    2. The December portion of the December 1 rent payment has expired.

    3. A physical count indicates that $350 of supplies is still on hand.

    4. The amount collected in transaction (m) is unearned at December 31.

    5. Three days of wages for December 29, 30, and 31 are unpaid; the unpaid amount of $1,500 will be included in the first Friday wages payment in January.

    6. The truck has an estimated useful life of 4 years.

    Required:

    1. Open additional general ledger T-accounts for the following: Supplies (173), Accumulated Depreciation – Truck (194), Wages Payable (237), Unearned Revenue (249), Depreciation Expense – Truck (624), Insurance Expense (631), and Rent Expense (654).

    2. Prepare all necessary adjusting entries. Omit descriptions.

    3. Post the entries to general ledger T-accounts and calculate balances.

    4. Prepare an adjusted trial balance at December 31, 2015.

    PROBLEM 3–6 (LO6) Closing Accounts

    Required:

    1. Using the adjusted trial balance answer from Problem 3–5, journalize the appropriate closing entries (create additional accounts if required).

    2. Prepare a post-closing trial balance.

    PROBLEM 3–7 (LO1,2,3,4,5,6) Comprehensive Accounting Cycle Review Problem

    The unadjusted trial balance of Packer Corporation showed the following balances at the end of its first 12-month fiscal year ended August 31, 2015:

    Balance
    Debits Credits
    Cash $12,000
    Accounts Receivable 3,600
    Prepaid Insurance -0-
    Supplies 2,500
    Land 15,000
    Building 60,000
    Furniture 3,000
    Equipment 20,000
    Accumulated Depreciation – Building $
     
    -0-
    Accumulated Depreciation – Equipment
     
    -0-
    Accumulated Depreciation – Furniture -0-
    Accounts Payable 4,400
    Salaries Payable -0-
    Interest Payable -0-
    Unearned Commissions Revenue 1,200
    Unearned Subscriptions Revenue 800
    Bank Loan 47,600
    Share Capital 52,100
    Retained Earnings -0-
    Income Summary -0-
    Commissions Earned 37,900
    Subscriptions Revenue 32,700
    Advertising Expense 4,300
    Depreciation Expense – Building -0-
    Depreciation Expense – Equipment -0-
    Depreciation Expense – Furniture -0-
    Insurance Expense 1,800
    Interest Expense 2,365
    Salaries Expense 33,475
    Supplies Expense 15,800
    Utilities Expense 2,860
     
    Totals
    $176,700 $176,700

    At the end of August, the following additional information is available:

    1. The company's insurance coverage is provided by a single comprehensive 12-month policy that began on March 1, 2015.

    2. Supplies on hand total $2,850.

    3. The building has an estimated useful life of 50 years.

    4. The furniture has an estimated useful life of ten years.

    5. The equipment has an estimated useful life of 20 years.

    6. Interest of $208 on the bank loan for the month of August will be paid on September 1, when the regular $350 payment is made.

    7. A review of the unadjusted balance in the unearned commissions revenue account indicates the unearned balance should be $450.

    8. A review of the unadjusted balance in the subscription revenue account reveals that $2,000 has not been earned.

    9. Salaries that have been earned by employees in August but are not due to be paid to them until the next payday (in September) amount to $325.

    Required:

    1. Set up necessary general ledger T-accounts and record their unadjusted balances. Create and assign account numbers that you deem appropriate.

    2. Prepare the adjusting entries. Descriptions are not needed.

    3. Post the adjusting entries to the general ledger T-accounts and calculate balances.

    4. Prepare an adjusted trial balance at August 31, 2015.

    5. Prepare an income statement and balance sheet.

    6. Prepare and post the closing entries.

    7. Prepare a post-closing trial balance.

    PROBLEM 3–8 (LO1,2,3) Challenge Question – Adjusting Entries

    Below is an unadjusted trial balance for Smith and Smith Co., at June 30, 2016.

    Smith and Smith Co.
    Unadjusted Trial Balance
    At June 30, 2016
     
    Debit
     
    Credit
    Cash $ 50,400
    Accounts receivable 25,000
    Shop supplies 1,500
    Prepaid insurance expense 4,500
    Prepaid advertising expense 2,000
    Prepaid rent expense
    Building 74,000
    Accumulated depreciation, building $
    Equipment 10,000
    Accumulated depreciation, equipment 2,000
    Accounts payable 12,000
    Accrued salaries payable 15,500
    Interest payable
    Income taxes payable
    Notes payable 20,000
    Unearned service revenue 30,000
    Share capital 1,000
    Retained earnings 24,900
    Service revenue 125,000
    Salaries expense 22,000
    Insurance expense
    Interest expense
    Shop supplies expense 200
    Advertising expense 2,200
    Depreciation expense 1,400
    Maintenance service expense 5,200
    Rent expense 20,000
    Income tax expense
    Utilities expense 12,000
    $ 230,400 $ 230,400

    Additional information for June not yet recorded:

    1. Unbilled and uncollected work to June 30 totals $45,000.

    2. An analysis of prepaid advertising shows that $500 of the balance was consumed.

    3. A shop supplies count on June 30 shows that $1,200 are on hand.

    4. Equipment has an estimated useful life of ten years and an estimated residual value of $500.

    5. The records show that fifty percent of the work, for a $10,000 fee received in advance from a customer and recorded last month, is now completed.

    6. Salaries of $5,800 for employees for work done to the end of June has not been paid.

    7. Utilities invoice for services to June 22 totals $3,500.

    8. Accrued revenues of $7,800 previously recorded to accounts receivable were collected.

    9. A building was purchased at the end of May. Its estimated useful life is fifty years and has an estimated residual value of $10,000.

    10. Rent expense of $5,000 cash for July has been paid and recorded directly to rent expense.

    11. Interest for the 6% note payable has not yet been recorded for June.

    12. Income taxes of $3,000 is owing but not yet paid.

    13. Unrecorded and uncollected service revenue of $9,000 has been earned.

    14. A two year, $1,800 insurance policy was purchased on June 1 and recorded to prepaid insurance expense.

    15. The prior balance in the unadjusted prepaid insurance account (excluding the insurance in item n. above), shows that $300 of that balance is not yet used.

    Required:

    1. Prepare the adjusting and correcting entries for June.

    2. Prepare an adjusted trial balance at June 30, 2016.

    PROBLEM 3–9 (LO4) Challenge Question – Preparation of Financial Statements

    Using the adjusted trial balance in PROBLEM 3–8 above:

    Required: Prepare an income statement, statement of changes in equity and a balance sheet as at June 30, 2016. (Hint: For the balance sheet, also include a subtotal for each asset's book value).

    PROBLEM 3–10 (LO6) Closing Entries and Post-Closing Trial Balance

    Required: Using the adjusted trial balance in PROBLEM 3–8 above:

    1. Assuming that June 30, 2016, is the year-end, prepare the closing journal entries.

    2. Prepare a post-closing trial balance at June 30, 2016.