Accounting Solution 3.3 (Accounting for Deferrals)
We will first draw a table and record transactions and then explain them:
| Event / |
Total Assets |
|
|
|
Equity |
||||
| Asset 1 |
+ |
Asset 2 |
= |
Liabilities |
+ |
Contributed |
+ |
Retained |
|
| 1 |
(2,400) |
|
2,400 |
|
n/a |
|
n/a |
|
n/a |
| 1 - Adj. |
n/a |
|
(1,400) |
|
n/a |
|
n/a |
|
(1,400) |
| 2 |
(1,000) |
|
1,000 |
|
n/a |
|
n/a |
|
n/a |
| 2 - Adj. |
n/a |
|
(700) |
|
n/a |
|
n/a |
|
(700) |
| 3 |
(5,000) |
|
5,000 |
|
n/a |
|
n/a |
|
n/a |
| 3 - Adj. |
n/a |
|
(800) |
|
n/a |
|
n/a |
|
(800) |
| 4 |
10,000 |
|
n/a |
|
10,000 |
|
n/a |
|
n/a |
| 4 - Adj. |
n/a |
|
n/a |
|
525 |
|
n/a |
|
(525) |
| 5 |
3,000 |
|
n/a |
|
3,000 |
|
n/a |
|
n/a |
| 5 - Adj. |
n/a |
|
n/a |
|
(1,750) |
|
n/a |
|
1,750 |
| 6 |
(15,000) |
|
15,000 |
|
n/a |
|
n/a |
|
n/a |
| 6 - Adj. |
n/a |
|
125 |
|
n/a |
|
n/a |
|
125 |
Event No.1. Paying cash ($2,400) in advance for office space acts to decrease Cash (Asset 1) and increase Prepaid Rent (Asset 2). This is an asset exchange transaction.
Adjustment to Event No.1. The company paid rent for a year in advance; thus, the company must recognize an expense for the amount of rent used during the current accounting period (from June to December). The rent expense calculations are as follows: $2,400 x (7 months / 12) = $1,400. The adjustment causes Prepaid Rent (Asset 2) and Retained Earnings (Equity) to decrease by the like amount. This represents an asset use transaction.
Event No.2. Supplies purchase decreases Cash (Asset 1) and increases Supplies (Asset 2); an asset use transaction.
Adjustment to Event No.2. The Company must recognize as an expense the amount of supplies used during the accounting period. As of December 31, $300 of supplies remained on hand, $700 of them ($1,000 - $300) was used during the year. The adjusting entry results in a decrease in Supplies (Asset 2) and Retained Earnings (Equity). This is an asset use transaction.
Event No.3. Buying office equipment decreases Cash (Asset 1) and increases Office Equipment (Asset 2). This is an asset exchange transaction.
Adjustment to Event No.3. At the accounting period end, the company must recognize as an expense the portion of the equipment cost used during the year. The straight-line method is used, so the following calculations apply: ($5,000 - $1,000) / 5 years = $800. Accumulated Depreciation goes up and Retained Earnings (Equity) goes down. Note that when Accumulated Depreciation increases, Office Equipment decreases. The decrease takes place because Accumulated Depreciation is a contra asset account that is subtracted from the Office Equipment account (Asset 2).
Event No.4. Borrowing money $10,000 from a bank acts to increase both Cash (Asset 1) and Note Payable (Liabilities); asset source transaction.
Adjustment to Event No.4. The company must record the accrual of the interest payable on December 31. The amount is calculated as follows: $10,000 x 7% x (9 months / 12) = $525. Note that we recognize interest payable for 9 months only (from April to December). Interest Payable (Liabilities) increases and Retained Earnings (Equity) decreases. This is a claim exchange transaction.
Event No.5. $3,000 cash was received for services to be performed in the future. The transaction acts to increase both Cash (Asset 1) and Unearned Revenue (Liabilities). This is an asset source transaction.
Adjustment to Event No.5. At the accounting period end, some services were provided; therefore, an appropriate revenue amount must be recognized. The amount to be taken from Unearned Revenue (Liabilities) and posted to Retained Earnings (Equity) is calculated as follows: $3,000 x (7 months / 12) = $1,750. The transaction is a claim exchange one.
Event No.6. Investment in a $15,000 certificate of deposit acts to decrease Cash (Asset 1) and increase Certificate of Deposit (Asset 2). This represents an asset exchange transaction.
Adjustment to Event No.6. The company must record the amount of the interest receivable on the CD on December 31. The CD was purchased on October 31, so the amount to be recorded is: $15,000 x 5% x (2 months / 12) = $125. Interest Receivable (Asset 1) and Retained Earnings (Equity) increase; asset use transaction.
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