Principles of Accounting: Chapter 3 Study Guidance – Adjusting and Closing Entries

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Q1. Exercise 3-2: Determining when to recognize revenue

Background

Topic: Revenue Recognition (Accrual Accounting)

This question tests your understanding of when revenue should be recognized under the accrual basis of accounting, which is a core principle in financial accounting. The accrual basis requires that revenue is recognized when earned, not necessarily when cash is received.

Key Terms and Concepts:

Revenue Recognition Principle: Revenue is recognized when it is earned, regardless of when cash is received.
Accrual Basis Accounting: Revenues and expenses are recorded when they are earned or incurred, not when cash changes hands.

Step-by-Step Guidance

Read each scenario carefully and identify when the service or product is actually delivered or earned.
Determine if the revenue should be recognized in December or a later period based on when the earning process is complete.
For advance payments (like tickets or deposits), consider whether the service has been performed by December.
Set up a table or list to organize each scenario, noting the amount and the period in which revenue should be recognized.

Try solving on your own before revealing the answer!

Final Answer:

See below for the recognized revenue in December for each scenario:

a. $0 (Game is in March, revenue recognized when played)
b. $0 (Service not yet performed by December 31)
c. $10,000 (Delivery services performed in December)
d. $0 (Writing not completed by December 31)

Revenue is only recognized when earned, not when cash is received in advance.

Q2. Exercise 3-3: Determining when to recognize expenses

Background

Topic: Expense Recognition (Matching Principle)

This question tests your understanding of when expenses should be recognized under the accrual basis of accounting. Expenses are recognized when incurred, not necessarily when paid.

Key Terms and Concepts:

Expense Recognition Principle (Matching Principle): Expenses are recognized in the period in which they help generate revenue.
Accrual Basis Accounting: Expenses are recorded when incurred, not when cash is paid.

Step-by-Step Guidance

Review each scenario and identify if the expense relates to December or a future period.
For unpaid bills, determine if the expense was incurred by December 31.
For prepaid expenses (like insurance), allocate the cost to the period covered by the policy.
For purchases for future use (like supplies for a January meeting), consider if the expense should be recognized in December or January.

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Final Answer:

a. $0 (Bill not paid, but expense incurred in December)
b. $48,000 (Insurance policy for December, expense recognized in December)
c. $0 (Supplies purchased for January meeting, expense recognized in January)

Expenses are recognized when incurred, not when paid.

Q3. Exercise 3-6: Preparing adjusting entries

Background

Topic: Adjusting Journal Entries

This question tests your ability to prepare adjusting entries at year-end to ensure that revenues and expenses are recognized in the correct period.

Key Terms and Concepts:

Adjusting Entries: Journal entries made at the end of an accounting period to allocate income and expenses to the correct period.
Prepaid Expenses, Accrued Expenses, Unearned Revenue: Common types of accounts requiring adjustment.

Step-by-Step Guidance

Read each scenario and identify what adjustment is needed (e.g., depreciation, insurance, supplies, prepaid rent, wages).
Calculate the amount that should be recognized as expense or revenue for the period.
Determine the correct accounts to debit and credit for each adjustment.
Set up the adjusting journal entry, but stop before posting the final amounts.

Try solving on your own before revealing the answer!

Final Answer:

Sample adjusting entries:

a. Depreciation Expense (debit), Accumulated Depreciation (credit)
b. Insurance Expense (debit), Prepaid Insurance (credit)
c. Supplies Expense (debit), Supplies (credit)
d. Rent Expense (debit), Prepaid Rent (credit)
e. Wages Expense (debit), Wages Payable (credit)

Amounts are based on the calculations from each scenario.

Q4. Exercise 3-7: Adjusting and paying accrued wages

Background

Topic: Accrued Expenses (Wages)

This question tests your understanding of how to record accrued wages at year-end and the subsequent payment of those wages.

Key Terms and Concepts:

Accrued Expenses: Expenses that have been incurred but not yet paid or recorded.
Wages Payable: A liability account representing wages owed to employees.

Step-by-Step Guidance

Calculate the total wages earned by employees for the days worked in December that have not yet been paid.
Prepare the adjusting entry to record the accrued wages at December 31.
Prepare the journal entry to record the payment of wages in January, including both the accrued amount and any additional wages earned in January.

Try solving on your own before revealing the answer!

Final Answer:

a. Adjusting entry: Debit Wages Expense, Credit Wages Payable for the amount earned but unpaid as of December 31.

b. Payment entry: Debit Wages Payable and Wages Expense, Credit Cash for the total amount paid on January 4.

Q5. Exercise 3-8: Adjusting and paying accrued expenses

Background

Topic: Accrued Expenses and Adjusting Entries

This question tests your ability to prepare adjusting entries for accrued expenses and record their subsequent payment.

Key Terms and Concepts:

Accrued Expenses: Expenses incurred but not yet paid or recorded.
Interest Payable, Salaries Payable: Common accrued expenses at period-end.

Step-by-Step Guidance

For each scenario, determine the amount of expense that has accrued by April 30.
Prepare the adjusting entry to recognize the accrued expense at April 30.
Prepare the entry to record payment of the expense in May, clearing the payable account.

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Final Answer:

a. Debit Legal Services Expense, Credit Accounts Payable for the amount owed as of April 30.
b. Debit Interest Expense, Credit Interest Payable for the accrued interest.
c. Debit Salaries Expense, Credit Salaries Payable for the amount owed as of April 30.

Q6. Exercise 3-9: Preparing adjusting entries

Background

Topic: Adjusting Entries for Year-End

This question tests your ability to prepare adjusting entries for various year-end scenarios, including accrued expenses, depreciation, supplies, and interest revenue.

Key Terms and Concepts:

Depreciation Expense: Allocation of the cost of a fixed asset over its useful life.
Prepaid Insurance, Supplies, Interest Revenue: Accounts that often require adjustment at year-end.

Step-by-Step Guidance

Identify the type of adjustment needed for each scenario (expense, revenue, asset, liability).
Calculate the amount to be adjusted based on the information provided (e.g., supplies used, insurance expired, interest earned).
Prepare the adjusting journal entry, specifying which accounts to debit and credit.

Try solving on your own before revealing the answer!

Final Answer:

a. Debit Wages Expense, Credit Wages Payable for $8,000.
b. Debit Depreciation Expense, Credit Accumulated Depreciation for $18,000.
c. Debit Supplies Expense, Credit Supplies for the amount used.
d. Debit Insurance Expense, Credit Prepaid Insurance for the expired portion.
e. Debit Interest Receivable, Credit Interest Revenue for the interest earned but not yet received.

Q7. Exercise 3-11: Preparing adjusting entries—accrued revenues and expenses

Background

Topic: Accrued Revenues and Expenses

This question tests your ability to prepare adjusting entries for revenues earned but not yet received and expenses incurred but not yet paid.

Key Terms and Concepts:

Accrued Revenues: Revenues earned but not yet received or recorded.
Accrued Expenses: Expenses incurred but not yet paid or recorded.

Step-by-Step Guidance

For each scenario, determine if revenue or expense has been earned/incurred but not yet recorded.
Calculate the amount to be accrued for each case.
Prepare the adjusting entry, debiting or crediting the appropriate accounts (e.g., Interest Receivable, Wages Payable).

Try solving on your own before revealing the answer!

Final Answer:

a. Debit Accounts Receivable, Credit Service Revenue for $2,000.
b. Debit Wages Expense, Credit Wages Payable for $1,000.
c. Debit Interest Receivable, Credit Interest Revenue for $400.
d. Debit Interest Receivable, Credit Interest Revenue for $300.
e. Debit Salary Expense, Credit Salaries Payable for $900.

Q8. Exercise 3-14: Analyzing effects of adjusting entries on financial statements

Background

Topic: Financial Statement Impact of Adjusting Entries

This question tests your ability to analyze how adjusting entries affect net income, assets, liabilities, and equity.

Key Terms and Concepts:

Adjusting Entries: Affect various accounts and can increase or decrease net income, assets, liabilities, or equity.

Step-by-Step Guidance

For each adjusting entry, determine which accounts are affected (e.g., expense, revenue, asset, liability).
Decide whether each account increases or decreases as a result of the entry.
Fill in the table with the direction (+ or -) and amount of the effect for each entry.

Try solving on your own before revealing the answer!

Final Answer:

Each adjusting entry will have a specific impact on net income, assets, liabilities, and equity. For example, accruing an expense decreases net income and equity, and increases liabilities.

Q9. Exercise 3-13: Preparing adjusting entries

Background

Topic: Year-End Adjusting Entries

This question tests your ability to prepare adjusting entries for depreciation, prepaid insurance, unearned revenue, wages, and interest revenue at year-end.

Key Terms and Concepts:

Depreciation, Prepaid Insurance, Unearned Revenue, Wages Payable, Interest Receivable: Common accounts requiring adjustment.

Step-by-Step Guidance

Identify the adjustment needed for each scenario (e.g., allocate prepaid amounts, recognize earned revenue, accrue expenses).
Calculate the amount to be adjusted for each account.
Prepare the adjusting journal entry, specifying the accounts to debit and credit.

Try solving on your own before revealing the answer!

Final Answer:

a. Debit Depreciation Expense, Credit Accumulated Depreciation for $5,000.
b. Debit Insurance Expense, Credit Prepaid Insurance for the expired portion.
c. Debit Unearned Revenue, Credit Consulting Revenue for the earned portion.
d. Debit Wages Expense, Credit Wages Payable for $1,200.
e. Debit Interest Receivable, Credit Interest Revenue for $400.

Q10. Exercise 3-18: Computing Income Summary and ending retained earnings from closing entries

Background

Topic: Closing Entries and Retained Earnings

This question tests your ability to compute the balance of the Income Summary account after closing revenue and expense accounts, and to determine the ending balance of Retained Earnings after all closing entries are posted.

Key Terms and Concepts:

Income Summary: A temporary account used to close revenue and expense accounts at the end of the period.
Retained Earnings: The cumulative net income retained in the company after dividends are paid.

Step-by-Step Guidance

Add up all revenue accounts and all expense accounts to determine net income for the period.
Close revenue and expense accounts to the Income Summary account.
Close the Income Summary account to Retained Earnings, and subtract dividends to find the ending balance.

Try solving on your own before revealing the answer!

Final Answer:

1. The balance of the Income Summary account after closing revenue and expense accounts is the net income for the period.

2. The ending balance of Retained Earnings is the beginning balance plus net income minus dividends.

Q11. Exercise 3-19: Preparing and posting closing entries

Background

Topic: Closing Journal Entries

This question tests your ability to prepare and post closing entries for revenue, expense, and dividend accounts at year-end.

Key Terms and Concepts:

Closing Entries: Journal entries made at the end of an accounting period to transfer balances from temporary accounts to permanent accounts.
Income Summary, Retained Earnings: Accounts used in the closing process.

Step-by-Step Guidance

Close all revenue accounts to the Income Summary account.
Close all expense accounts to the Income Summary account.
Close the Income Summary account to Retained Earnings.
Close the Dividends account to Retained Earnings.

Try solving on your own before revealing the answer!

Final Answer:

Closing entries will zero out the temporary accounts and update Retained Earnings for the period's net income and dividends.

Q12. Exercise 3-20: Preparing closing entries and a post-closing trial balance

Background

Topic: Closing Entries and Post-Closing Trial Balance

This question tests your ability to prepare closing entries and a post-closing trial balance, ensuring all temporary accounts are closed and only permanent accounts remain.

Key Terms and Concepts:

Post-Closing Trial Balance: A list of all permanent accounts and their balances after closing entries are made.

Step-by-Step Guidance

Prepare closing entries for all revenue, expense, and dividend accounts.
Post the closing entries to the ledger accounts.
Prepare a trial balance listing only permanent accounts and their balances.

Try solving on your own before revealing the answer!

Final Answer:

The post-closing trial balance will include only asset, liability, and equity accounts with updated balances after closing entries.

Q13. Exercise 3-21: Preparing an income statement & statement of retained earnings

Background

Topic: Financial Statement Preparation

This question tests your ability to prepare an income statement and a statement of retained earnings using an adjusted trial balance.

Key Terms and Concepts:

Income Statement: Reports revenues and expenses to show net income for the period.
Statement of Retained Earnings: Shows changes in retained earnings, including net income and dividends.

Step-by-Step Guidance

List all revenue and expense accounts to calculate net income.
Use the net income to update the retained earnings balance, subtracting any dividends paid.
Prepare the statements in proper format, but stop before final calculations.

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Final Answer:

Income Statement: Net income is calculated as total revenues minus total expenses.

Statement of Retained Earnings: Ending retained earnings = Beginning retained earnings + Net income - Dividends.

Q14. Exercise 3-24: Preparing a classified balance sheet

Background

Topic: Classified Balance Sheet Preparation

This question tests your ability to prepare a classified balance sheet, organizing assets and liabilities into current and long-term categories.

Key Terms and Concepts:

Classified Balance Sheet: Presents assets and liabilities in order of liquidity and maturity.
Current vs. Long-Term: Current assets/liabilities are expected to be used or settled within one year; long-term are beyond one year.

Step-by-Step Guidance

List all assets, separating current assets from long-term assets.
List all liabilities, separating current liabilities from long-term liabilities.
Calculate total assets, total liabilities, and equity, but stop before final totals.

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Final Answer:

The classified balance sheet will show current assets, long-term assets, current liabilities, long-term liabilities, and equity, with proper subtotals and totals.

Q15. Exercise 3-25: Computing and interpreting profit margin

Background

Topic: Profit Margin Ratio

This question tests your ability to compute the profit margin for several companies and interpret which is most profitable.

Key Terms and Concepts:

Profit Margin: Net income divided by net sales, expressed as a percentage.

Step-by-Step Guidance

For each company, divide net income by net sales to compute the profit margin.
Compare the profit margins to determine which company is most profitable.
Interpret the profit margin for company c, explaining what it means in context.

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Final Answer:

Profit margin = Net income / Net sales. The company with the highest profit margin is the most profitable. For company c, the profit margin indicates the percentage of each sales dollar that is profit.

Q16. Exercise 3-26: Computing the current ratio

Background

Topic: Current Ratio (Liquidity Analysis)

This question tests your ability to compute and interpret the current ratio, a measure of a company's ability to pay short-term obligations.

Key Terms and Concepts:

Current Ratio: Current assets divided by current liabilities.

Step-by-Step Guidance

Use the adjusted trial balance to find total current assets and current liabilities for Wilson Trucking Company.
Divide current assets by current liabilities to compute the current ratio.
Compare the result to the competitor's ratio of 1.5 to determine which company is better able to pay short-term obligations.

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Final Answer:

Current ratio = Current assets / Current liabilities. The company with the higher current ratio is better able to pay its short-term obligations.

Q17. Exercise 3-27: Computing and analyzing the current ratio

Background

Topic: Current Ratio Comparison

This question tests your ability to calculate and compare the current ratios of several companies to assess their liquidity.

Key Terms and Concepts:

Current Ratio: Current assets divided by current liabilities.

Step-by-Step Guidance

For each company, divide current assets by current liabilities to compute the current ratio.
Compare the ratios to determine which company is in the best position to pay its short-term obligations.

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Final Answer:

The company with the highest current ratio is in the best position to pay its short-term obligations.

Q18. Exercise 3-28A: Adjusting for prepaids recorded as expenses and unearned revenues recorded as revenues

Background

Topic: Adjusting Entries for Prepaids and Unearned Revenues

This question tests your ability to adjust accounts for prepaids and unearned revenues at period-end.

Key Terms and Concepts:

Prepaid Expenses: Payments made in advance for expenses; require adjustment as the benefit is used.
Unearned Revenue: Cash received before services are performed; recognized as revenue when earned.

Step-by-Step Guidance

Identify which prepaids and unearned revenues need adjustment at December 31.
Calculate the amount to be recognized as expense or revenue for the period.
Prepare the adjusting entries, debiting or crediting the appropriate accounts.

Try solving on your own before revealing the answer!

Final Answer:

Adjusting entries will move amounts from prepaid or unearned accounts to expense or revenue accounts as appropriate.

Q19. Exercise 3-29A: Recording and reporting revenues received in advance

Background

Topic: Unearned Revenue and Service Revenue Recognition

This question tests your ability to record journal entries for revenues received in advance and to report unearned and earned revenues at period-end.

Key Terms and Concepts:

Unearned Revenue: Liability account for cash received before services are performed.
Service Revenue: Revenue account for services performed.

Step-by-Step Guidance

Record initial receipt of cash as unearned revenue.
As services are performed, transfer amounts from unearned revenue to service revenue.
At month-end, report the balances of unearned and earned revenue on the financial statements.

Try solving on your own before revealing the answer!

Final Answer:

Journal entries will debit cash and credit unearned revenue when cash is received, and debit unearned revenue and credit service revenue as services are performed.

Q20. Exercise 3-30: Assigning account balances on a work sheet

Background

Topic: Work Sheet Columns and Account Classification

This question tests your ability to classify accounts as debit or credit balances in the income statement or balance sheet columns of a work sheet.

Key Terms and Concepts:

Work Sheet: An accounting tool used to organize and classify account balances for financial statement preparation.
Debit/Credit, Income Statement/Balance Sheet: Accounts are classified based on their normal balance and financial statement placement.

Step-by-Step Guidance

For each account, determine if it normally has a debit or credit balance.
Decide if the account appears on the income statement or balance sheet.
Assign the correct letter (A, B, C, or D) based on the classification.

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Final Answer:

Each account is classified as debit or credit in the income statement or balance sheet columns based on its normal balance and financial statement placement.