Chapter 4: Adjustments, Financial Statements, and the Quality of Earnings

AJE 1
Unearned Revenue AJE 5
Buildings and equipment
Original JE
Dr. cash Dr. Depreciation Expense
Cr. Unearned Revenue Cr. Accumulated Depreciation

Adjustment AJE 6
Dr. Unearned Revenue Wages
Cr. Revenue
Original Adjustment
AJE 2 Dr. Wages Expense
Interest revenue (earned interest but will be paid Cr. Wages Payable
next period)
Original JE Adjustment
Dr. Interest Receivable Dr. Wages Payable
Cr. Interest revenue Cr. Cash

AJE 3 AJE 7
Supplies Interest on debt

Beginning balance Dr. Interest Expense

+purchases Cr. Interest Receivable
-amount at end of period
=supplies used AJE 8
Utilities
t account
Dr. Utilities Expense (this is the adj. you haven’t
Original JE recorded this yet)
Dr. Supplies Cr. Utilities Payable
Cr. Cash
Adjustment Dr. utilities Payable
Dr. Supplies Expense Cr.
Cr. Supplies
AJE 9
AJE 4 Income Tax Payable
Prepaid expense
Dr. Income Tax Expense
Original JE Cr. Income tax payable
Dr. Prepaid Rent
Cr. Cash Dr. Income tax payable
Cr. Cash
Adjustment
Dr. Rent Expense
Cr. Prepaid Rent
EPS: Earnings per share

Net Income .
Avg. # of shares of common stock outstanding

Only ratio to be disclosed on the income statement.

Total Asset Turnover Ratio: Net Sales

Avg Total Assets

Measures of efficient management is at using assets to generate sales.

Closing Entries
Revenue, expenses, gains and losses are used to accumulate data for the current accounting period only

1. Transfer balances to retained earnings

2. Establish a zero balance in start the accumulation process again

Dr. Revenue
Dr. Gain
Cr. Wages Expense
Cr. Loss
Cr. Retained Earnings

Practice Problems

Adjusting Journal Entries: E4-9:

A. Dr. Accounts Receivable $3,300

Cr. Service Revenue $3,300

B. Advertising Expense $1650 2200x9/12

Prepaid advertising $1650

C. Interest Expense 5500

Interest Payable 5500

D. Unearned Storage Revenue 750 4500x1/6

Storage revenue 750

E. Depreciation Expense 18000

Accumulated depreciation 18000
F. Supplies Expense 48500
Supplies 48,500

G. Wages Expense 5600

Wages Payable 5600
E4-11
Balance Sheet Income Statement
Stockholders’ Net
Transaction Assets Liabilities Equity Revenues Expenses Income
(a) +3,300 NE +3,300 +3,300 NE +3,300
(b) –1,650 NE –1,650 NE +1,650 –1,650
(c) NE +5,500 –5,500 NE +5,500 –5,500
(d) NE –750 +750 +750 NE +750
(e) –18,000 NE –18,000 NE +18,000 –18,000
(f) –48,500 NE –48,500 NE +48,500 –48,500
(g) NE +5,600 –5,600 NE +5,600 –5,600

P4-3

a. Depreciation expense (+E, SE) .................................. 3,500

Accumulated depreciation (+XA, A) .................. 3,500

b. Supplies expense (+E, SE) ........................................ 1,350

Supplies (A) ...................................................... 1,350
(Beg. Inventory of $500 + Purchases $1,000 – Ending Inventory $150)

c. Repairs expense (+E, SE) .......................................... 2,600

Accounts payable (+L) ....................................... 2,600

d. Property tax expense (+E, SE) ................................... 1,800

Property tax payable (+L) ..................................... 1,800

e. Accounts receivable (+A) ............................................. 4,000

Service revenue (+R, +SE) ................................ 4,000

f. Insurance expense (+E, SE) ...................................... 150

Prepaid insurance (A)...................................... 150
($900 ÷ 36 months x 6 months of coverage)

g. Interest expense (+E, SE) .......................................... 390

Interest payable (+L) ............................................ 390
($13,000 x .12 x 3/12)

h. Income tax expense (+E, SE)..................................... 7,263

Income tax payable (+L) ....................................... 7,263
To accrue income tax expense incurred but not paid:
Income before adjustments (given) $30,000
Effect of adjustments (a) through (g) (5,790) (–$3,500–$1,350–$2,600
Income before income taxes 24,210 –$1,800+$4,000–$150–$390)
Income tax rate x 30%
Income tax expense $ 7,263
P4–6.

Req. 1
December 31 Adjusting Entries
(1) Accounts receivable (+A) ......................................... 1,820 (b)
Service revenue (+R, +SE) ........................... 1,820 (i)
To record service revenue earned, but not collected.

(2) Insurance expense (+E, SE) ................................. 130 (l)

Prepaid insurance (A) .................................. 130 (c)
To record insurance expired as an expense.

(3) Depreciation expense (+E, SE) .............................. 6,000 (k)

Accumulated depreciation, equipment (+XA, A) 6,000 (e)
To record depreciation expense.

(4) Income tax expense (+E, SE) ............................... 1,380 (m)

Income taxes payable (+L) ............................ 1,380 (f)
To record income taxes for the current year.

Req. 2
Amounts before Amounts after
Adjusting Entries Adjusting Entries
Revenues:
Service revenue $64,400 $66,220
Expenses:
Salary expense 55,470 55,470
Depreciation expense 6,000
Insurance expense 130
Income tax expense 1,380
Total expense 55,470 62,980
Net income (loss) $ 8,930 $ 3,240

Net income is $3,240 because this amount includes all revenues and all expenses (after the adjusting
entries). This amount is correct because it incorporates the effects of the revenue realization and
expense matching principles applied to all transactions whose effects extend beyond the period in
which the transactions occurred. Net income of $8,930 was not correct because expenses of $7,510
and revenues of $1,820 were excluded that should have been recorded in the current year.

Req. 3

Earnings per share = $3,240 net income  3,000 shares = $1.08 per share
P4–6. (continued)

Req. 4

Total asset turnover ratio = Sales (or Operating) Revenue  Average Total Assets
= $66,220  [($110,000 + $136,220)/2]
= $66,220  $123,110 = 0.538

The total asset turnover ratio indicates that, for every $1 of assets, Ramirez generated $0.538 in
revenues. Compared to the industry average of 0.49, Ramirez is more effective at utilizing assets to
generate sales than the average company in the industry.

Req. 5

Service revenue (R) ............................................... 66,220

Retained earnings (+SE) ................................. 3,240
Salary expense (E) ......................................... 55,470
Depreciation expense (E) ............................... 6,000
Insurance expense (E) ................................... 130
Income tax expense (E) ................................. 1,380