Question

PA4-2 Analyzing and Recording Adjusting Journal Entries [LO 4-1, LO 4-2]

Brokeback Towing Company is at the end of its accounting year, December 31, 2015. The following data that must be considered were developed from the company’s records and related documents:

a.	On July 1, 2015, a two-year insurance premium on equipment in the amount of $672 was paid and debited in full to Prepaid Insurance on that date. Coverage began on July 1.
b.	At the end of 2015, the unadjusted balance in the Supplies account was $1,000. A physical count of supplies on December 31, 2015, indicated supplies costing $330 were still on hand.
c.	On December 31, 2015, YY’s Garage completed repairs on one of Brokeback’s trucks at a cost of $830. The amount is not yet recorded. It will be paid during January 2016.
d.	On December 31, 2015, the company completed a contract for an out-of-state company for $8,100 payable by the customer within 30 days. No cash has been collected and no journal entry has been made for this transaction.
e.	On July 1, 2015, the company purchased a new hauling van. Depreciation for July–December 2015, estimated to total $2,900, has not been recorded.
f.	As of December 31, the company owes interest of $530 on a bank loan taken out on October 1, 2015. The interest will be paid when the loan is repaid on September 30, 2016. No interest has been recorded yet.
g.	Assume the income after the preceding adjustments but before income taxes was $33,000. The company’s federal income tax rate is 25%. Compute and record income tax expense.

Required:

1.

Give the adjusting journal entry required for each item at December 31, 2015. (If no entry is required for a transaction/event, select "No Journal Entry Required" in the first account field.) 2. If adjustments were not made each period, the financial results could be materially misstated. Determine the amount by which Brokeback's net income would have been understated, or overstated, had the adjustments in requirement 1 not been made.

Answer 1

1. Adjusting journal entries for the given information are as follows:

1. Insurance expense is calculated for 6 months out of the 2 year prepaid insurance ($672 x 6/24)

2. Supplies consumed is calculated by taking the difference between the unadjusted balance and the value arrived by count ($1,000 - $330)

3. Rent expense is recorded as miscelleneous expense.

4. Service rendered but is to be received in 30 days is recognized as accounts receivable.

5. Depreciation is provided as mentioned for the estimated amount of $2,900.

6. Interest on Bank Loan is recognized in the books.

7. Income tax expense is calculated at 25% on the income before tax ($33,000 x 25%)

2. Effect of the above adjustments on Net Income if the same have not been made:

The common principle that is to be followed is,

If an expense is not recognized, the income would be over stated.

If an item of revenue is not recognized, the income would be understated.

Therefore, the net result of not making adjusting entries would be an overstatement of Net Income by $5,248.

Hope this is helpful!!