Accruals and Deferrals
For the following situations, indicate whether each involves a deferred expense (DE), a deferred revenue (DR), an accrued liability (AL), or an accrued asset (AA).
Example: DE Office supplies purchased in advance of their use
__________ 1. Wages earned by employees but not yet paid
__________ 2. Cash collected from subscriptions in advance of publishing a magazine
__________ 3. Interest earned on a customer loan for which principal and interest have not yet been collected
__________ 4. One year's premium on life insurance policy paid in advance
__________ 5. Office building purchased for cash
__________ 6. Rent collected in advance from a tenant
__________ 7. State income taxes owed at the end of the year
Exercise: The Effect of Adjustments on the Accounting Equation
Determine whether recording each of the following adjustments will increase (I), decrease (D), or have no effect (NE) on each of the three elements of the accounting equation.
Assets ¼ Liabilities þ Stock. Equity
Example: Wages earned during the period but not yet paid are accrued. NE I D
1. Prepaid insurance is reduced for the portion of the policy that has expired during the period. ________ ________ ________
2. Interest incurred during the period but not yet paid is accrued. ________ ________ ________
3. Depreciation for the period is recorded. ________ ________ ________
4. Revenue is recorded for the earned portion of a liability for amounts collected in advance from customers. ________ ________ ________
5. Rent revenue is recorded for amounts owed by a tenant but not yet received. ________ ________ ________
6. Income taxes owed but not yet paid are accrued. ________ ________ ________
Exercise - The Accounting Cycle
The steps in the accounting cycle are listed in random order. Fill in the blank next to each step to indicate its order in the cycle. The first step in the cycle is filled in as an example. Order Procedure ________ Prepare a work sheet.
________ Close the accounts.
1 Collect and analyze information from source documents.
________ Prepare financial statements.
________ Post transactions to accounts in the ledger.
________ Record and post adjustments.
________ Journalize daily transactions.
Problem - Annual Adjustments
Palmer Industries prepares annual financial statements and adjusts its accounts only at the end of the year. The following information is available for the year ended December 31, 2014:
a. Palmer purchased computer equipment two years ago for $15,000. The equipment has an estimated useful life of five years and an estimated salvage value of $250.
b. The Office Supplies account had a balance of $3,600 on January 1, 2014. During 2014, Palmer added $17,600 to the account for purchases of office supplies during the year. A count of the supplies on hand at the end of December 2014 indicates a balance of $1,850.
c. On August 1, 2014, Palmer created a liability account, Customer Deposits, for $24,000. This sum represents an amount that a customer paid in advance and that will be earned evenly by Palmer over a six-month period.
d. Palmer rented some office space on November 1, 2014, at a rate of $2,700 per month. On that date, Palmer recorded Prepaid Rent for three months' rent paid in advance.
e. Palmer took out a 120-day, 9%, $200,000 note on November 1, 2014, with interest and principal to be paid at maturity.
f. Palmer operates five days per week with an average daily payroll of $500. Palmer pays its employees every Thursday. December 31, 2014, is a Wednesday.
Questions
1. For each of the preceding situations, identify and analyze the adjustment to be recorded on December 31, 2014.
2. Assume that Palmer's accountant forgets to record the adjustments on December 31, 2014. Will net income for the year be understated or overstated? by what amount?