Double-entry Accounting System

4.3.15 Analysis of interest payable / expense adjusting entry

After we saw all transactions pertaining to the accounting period, we need to make adjusting entries. Recall that adjusting entries are those made at year end (or any other fiscal period) to adjust revenues or expenses.

Adjustment No. 1. On May 31 Huske's Consultants borrowed $4,000 cash from the bank and agreed to return the money in a year and pay 7% annual interest (see Event No. 5). For the current accounting period, the interest expense amounted to $163 (i.e., $4,000 x 7% x [7 months / 12 months], rounded). The adjustment acts to increase liabilities and decrease equity. The increase in liabilities (Interest Payable) is recorded as a credit, and the decrease in equity (Interest Expense) is recorded as a debit:

Illustration 4-30: Effect of interest expense in T accounts

Assets

Liabilities

Equity

Interest Payable

Interest Expense

Credit
(A1) + 163

Debit
+ Expense

[- Equity]
(A1) 163

This is a claims exchange transaction:

Illustration 4-31: Effect of interest expense in the horizontal model

Assets	=	Liabilities	+	Equity	Rev.	-	Exp.	=	Net Inc.	Cash Flow
n/a	=	163	+	(163)	n/a	-	(163)	=	(163)	n/a

4.3.16 Analysis of prepaid rent adjusting entry

Adjustment No. 2.On June 1 Huske's Consultants prepaid rent for 12 months in amount of $2,000 (see Event No. 6). The rent expense to be recognized at the end of the period is calculated as follows: $2,000 x (7 months / 12 months) = $1,167 (rounded). Recognition of the rent expense acts to decrease assets and equity. The decrease in assets (Prepaid Rent) is recorded as a credit, and the decrease in equity (Rent Expense) is recorded as a debit:

Illustration 4-32: Effect of rent expense in T accounts

Assets		=	Liabilities	+	Equity
Prepaid Rent					Rent Expense
	Credit (A2) - 1,167				Debit + Expense [- Equity] (A2) 1,167

This is an asset use transaction:

Illustration 4-33: Effect of rent expense in the horizontal model

Assets	=	Liabilities	+	Equity	Rev.	-	Exp.	=	Net Inc.	Cash Flow
(1,167)	=	n/a	+	(1,167)	n/a	-	(1,167)	=	(1,167)	n/a

4.3.17 Analysis of unearned / earned revenue adjusting entry

Adjustment No. 3. On June 31, Huske's Consultants received $3,600 advance cash payment for services to be performed within a year after signing the contract (see Event No. 8). By December 31 the company had provided 10 months of service, so the amount to be recorded as revenue is $3,600 x (6 months / 12 months) = $1,800. This amount is transferred from liabilities (Unearned Revenue) to equity (Consulting Revenue). This revenue recognition acts to decrease liabilities and increase equity. The decrease in liabilities is recorded as a debit and the increase in equity is recorded as a credit:

Illustration 4-34: Effect of revenue recognition in T accounts

Assets	=	Liabilities	+	Equity
		Unearned Revenue		Consulting Revenue
		Debit (A3) -1,800			Credit + Revenue [+ Equity] (A3) + 1,800