Question

At the end of 2022, the following information is available for Great Adventures. Additional interest for five months needs to be accrued on the $30,000, 6% loan obtained on August 1, 2021. Recall that annual interest is paid each July 31. Assume that $10,000 of the $30,000 loan discussed above is due next year. By the end of the year, $20,000 in gift cards have been redeemed. The company had sold gift cards of $25,000 during the year and recorded those as Deferred Revenue. Great Adventures is a defendant in litigation involving a biking accident during one of its adventure races. The company believes the likelihood of payment occurring is probable, and the estimated amount to be paid is $12,000. For sales of MU watches, Great Adventures offers a warranty against defect for one year. At the end of the year, the company estimates future warranty costs to be $4,000.

1. Prepare the journal entries for transactions. (If no entry is required for a particular transaction/event, select "No Journal Entry Required" in the first account field.)

-Record the redeemed of gift cards

- Record the estimated future warranty costs

- Record entry to close the revenue accounts

- Record entry to close the expense accounts

Answer 1

Ans. A. Journal entry to record the redemption of gift cards:

Particulars	Debit Amount	Credit Amount
Deferred Revenue A/c	$20,000
Revenue A/c		$20,000

Since these gift cards were deferred revenue, so they were recorded as a liability ($25,000) in the balance sheet (Since amount was received in advance for goods not yet sold). Now, when gift cards worth $20,000 are redeemed by customers, deferred revenue account is debited by $20,000 (since liability is reduced) and revenue is recognized by crediting revenue account.

Ans. B. Journal entry to record estimated future warranty costs:

Particulars	Debit Amount	Credit Amount
Warranty Expense A/c	$4,000
Warranty Liability A/c		$4,000

As per the matching principle, the estimated warranty expense must be recognized in the period in which related goods have been sold, with a warranty liability to be recorded for estimated warranty expense. When warranty claims arise in the future, warranty liability account is debited and inventory account is credited for cost of goods replaced under warranty.

Ans. C. Journal entry to close the revenue accounts:

Particulars	Debit Amount	Credit Amount
Revenue A/c	$20,000
Income Summary A/c		$20,000

Based on the data provided, the revenue recognized during the year is $20,000 from gift cards redeemed. Same is closed to Income Summary account.

Ans.D. Journal entry to close the expense accounts:

Particulars	Debit Amount	Credit Amount
Income Summary A/c	$17,800
Interest expense A/c		$1,800
Lawsuit expense A/c		$12,000
Warranty expense A/c		$4,000

Working notes :

Following is the list of journal entries for the expenses during the year :

S.No.	Particulars	Debit Amount	Credit Amount
1	Interest expense A/c	$1,800
	Interest liability A/c		$1,800
	(Interest expense on $30,000 @ 6% for the year ended 2022)
2	Lawsuit expense A/c	$12,000
	Lawsuit liability A/c		$12,000
3	Warranty expense A/c	$4,000
	Warranty liability A/c		$4,000

1. Interest expense is calculated for full year since thought interest for 7 months is paid and balance 5 months is accrued, the total interest expense for the year will by $30,000 * 6% = $1,800.

2. Since the contingent loss on lawsuit is probable and amount for same can be estimated, lawsuit expense needs to be recorded for estimated lawsuit amount.

3. Warranty expense as above.