College Accounting, by Heintz and Parry Chapter 5: Adjusting Entries

College Accounting, by Heintz and Parry Chapter 5: Adjusting Entries and the Work Sheet

Eddie was ready to do year-end financial statements, starting with a work sheet, a form that summarizes the accounts so that financial statements are easy to create. To do this, he needed to calculate adjusting entries: entries that reflect changes that occur in the business over time but are best summarized in one entry (at financial statement time). For example, Eddie used up supplies during the period, but didn’t make entries every time he used tape or some letterhead. He counted the supplies at year end and found 25 worth, but his supplies account had a 60 debit balance (the amount he spent). Questions: 1) What needs to be done to the supply account (debit or credit) and for what amount? 2) What new account would be the other half of this transaction?

Answers: 1)Supplies would get credited (it’s decreasing) for 35 (60-25), to reduce the balance of 60 to 25. 2) Supplies expense would get debited (the discarded supplies represent assets used up when trying to produce revenue). Supplies Expense 12/31 35 Supplies 11/10 60 Bal. 25 12/31 35

Another adjusting entry is for insurance, because Eddie paid 120 for 1 year’s Prepaid Insurance in November, but two of those months have passed. Thus, his books need to reflect that 20 worth of coverage has been used up, calculated as follows: ( 120/12 months 10 per month X 2 months 20) Questions: 1) What needs to be done to the Prepaid Insurance account (debit or credit) and for what amount? 2) What new account would be the other half of this transaction?

Answers: 1)Prepaid Insurance would get credited (it’s decreasing) for 20, to reduce the balance to 100. 2) Insurance expense would get debited to show that part of the asset was used up. Insurance Expense 12/31 20 Prepaid Insurance 11/10 120 Bal. 100 12/31 20

The third adjusting entry is for unpaid wages. Most businesses pay hourly wages on a weekly or biweekly basis, with a few days of delay while the paychecks are calculated and prepared, so at year end the employees haven’t been paid for all hours worked. In Eddie’s case, he hasn’t paid his bandmates for the November gig, so he owes them 80. Questions: 1) What needs to be done to the wage expense account (debit or credit) and for what amount? 2) What new account would be the other half of this transaction?

Answers: 1) Wage Expense would get debited (it’s increasing) for 80. 2) Wages Payable (a liability) would get credited. Wage Expense 10/19 12/31 Bal. 80 80 160 Wages Payable 12/31 80

The final adjusting entry was to recognize that the musical instruments, 3 months older than when he purchased them, have decreased in value, as almost all long-lived assets do. This decrease in value that comes with wear and tear (and time) is called depreciation. Monthly depreciation is calculated as: Original Cost - Salvage Value Useful Life (in months) where salvage value is the amount you expect to sell it for when you feel it’s at the end of it’s useful life. In this case, the calculation would be: 2200 - 400 60 months and the result is 30 depreciation per month.

The final adjusting entry would be for 90 ( 30 X 3 months). Two new accounts are used. Depreciation Expense-Musical Instruments would get debited, and Accumulated Depreciation-Musical Instruments would get credited. We don’t credit Musical Instruments directly because we want the financial statements to show the original price paid, especially since depreciation is an estimated number. Accumulated Depreciation is a contra asset: an account whose credit balance (the reverse of most assets) is a subtraction from an asset. Depreciation Expense-M.I. 12/31 90 Accumulated Depr’n.-M.I. 12/31 90

At this point, Eddie put the adjusting entry amounts into the appropriate columns of his work sheet, next to his trial balance: Eddie and the Losers Work Sheet For Year Ended Dec. 31, 1999 Trial Balance Debits Credits 383 2200 Cash Musical Instruments Acc. Depn.-M.I. Supplies 60 Prepaid Insurance 120 Accts. Payable Wages Payable Eddie O’Hare, Capital Eddie O’Hare, Drawing 12 Gig Revenue Wage Expense 80 Equip. Rental Expense 30 Supply Expense Insurance Expense Depn. Exp.-M.I. 2885 Adjustments Debits Credits D) 90 A) 35 B) 20 360 C) 80 2000 525 2885 C) 80 A) 35 B) 20 D) 90 225 225

The next work sheet columns, the adjusted trial balance, are used to add or subtract the adjustments and make sure we still balance: Eddie and the Losers Work Sheet For Year Ended Dec. 31, 1999 Cash Musical Instruments Acc. Depn.-M.I. Supplies Prepaid Insurance Accts. Payable Wages Payable Eddie O’Hare, Capital Eddie O’Hare, Drawing Gig Revenue Wage Expense Equip. Rental Expense Supply Expense Insurance Expense Depn. Exp.-M.I. Trial Balance Debits Credits 383 2200 60 120 12 360 2000 12 525 80 30 2885 Adjustments Adj. Trial Bal. Debits Credits Debit Credit 383 2200 D) 90 90 A) 35 25 B) 20 100 360 C) 80 80 C) 80 2885 A) 35 B) 20 D) 90 225 225 2000 525 160 30 35 20 90 3055 3055

The 7th and 8th work sheet columns, the income statement, are used to total the revenue and expense accounts and calculate net income: Adj. Trial Balance Debits Credits Cash 383 Musical Instruments 2200 Acc. Depn.-M.I. 90 Supplies 25 Prepaid Insurance 100 Accts. Payable 360 Wages Payable 80 Eddie O’Hare, Capital 2000 Eddie O’Hare, Drawing 12 Gig Revenue 525 Wage Expense 160 Equip. Rental Expense 30 Supply Expense 35 Insurance Expense 20 Depn. Exp.-M.I. 90 3055 3055 Net Income Inc. Statement Bal. Sheet. Debits Credits Deb. Cred. 160 30 35 20 90 335 190 525 525 525 525

The 9th & 10th work sheet columns, the balance sheet, list non-income statement accounts and confirm net income (which should be the difference between the balance sheet debits and credits): Adj. Trial Balance Debits Credits Cash 383 Musical Instruments 2200 Acc. Depn.-M.I. 90 Supplies 25 Prepaid Insurance 100 Accts. Payable 360 Wages Payable 80 Eddie O’Hare, Capital 2000 Eddie O’Hare, Drawing 12 Gig Revenue 525 Wage Expense 160 Equip. Rental Expense 30 Supply Expense 35 Insurance Expense 20 Depn. Exp.-M.I. 90 3055 3055 Net Income Inc. Statement Bal. Sheet. Debits Credits Debit Credit 383 2200 90 25 100 360 80 2000 12 525 160 30 35 20 90 335 525 2720 2530 190 190 525 525 2720 2720

Later on, after the financial statements are done, Eddie would write the heading “Adjusting Entries” in the General Journal and journalize and post the entries. The first one is listed as an example: Date 1999 Description Adjusting Entries Dec. 31 Supplies Expense Supplies P. R. Debit Credit 35.00 35.00