Problem 2 - Accounting

Question

The following accounts were taken from the unadjusted trial balance of Dobro Co., a congressional lobbying firm. Indicate whether or not each account would normally require an adjusting entry. If the account normally requires an adjusting entry, use the following notation to indicate the type of adjustment: AE-Accrued Expense AR-Accrued Revenue DR-Deferred Revenue DE-Deferred Expense To illustrate, the answers for the first two accounts are shown below.

Step-by-Step Solution

Answer

Assess accounts for adjusting entries: AR (Accrued Revenue), Prepaid Insurance (Deferred Expense), Salaries Payable (Accrued Expense), Unearned Revenue (Deferred Revenue). Adjust according to incurred or deferred expenses/revenues.

Step 1: Understanding Adjusting Entries

Adjusting entries are made at the end of an accounting period to update account balances before financial statements are prepared. They typically involve accrued revenues, accrued expenses, deferred revenues, and deferred expenses.

Step 2: Review the Account List

Review each account on the trial balance to determine if an adjusting entry is needed. Common accounts requiring adjustments are interest, salaries, rent, and prepaid expenses.

Step 3: Evaluate Each Account

Assess each account: 1. Accounts Receivable - Normally requires adjustment if there's accrued revenue (AR). 2. Prepaid Insurance - Typically needs adjusting as deferred expense (DE). 3. Salaries Payable - Accrued expense (AE) adjustment is common. 4. Unearned Revenue - Usually adjusted as deferred revenue (DR). 5. Rent Expense - Defer adjustments for actual occupied periods. 6. Supplies - Count for consumption for adjustment as expense (AE). 7. Interest Expense - May need accrued expense (AE).

Step 4: Identify the Type of Adjustment

Based on the assessment, label each account type for its adjusting entry. 1. AR (Accounts Receivable) - AR: Accrued Revenue 2. DE (Prepaid Insurance) - DE: Deferred Expense 3. AE (Salaries Payable) - AE: Accrued Expense 4. DR (Unearned Revenue) - DR: Deferred Revenue 5. RE (Rent Expense) - DE, if applicable to prepaid 6. AE (Supplies) - Action depends on usage audit 7. AE (Interest Expense) - AE: Accrued Expense if interest was incurred but not paid

Step 5: Create Adjusting Entries (If Needed)

Document entries for those needing adjustments. Example: 1. Accounts Receivable Debit: Accounts Receivable (increase) Credit: Service Revenue (increase) 2. Prepaid Insurance (reducing prepaid asset as expensed over time) Debit: Insurance Expense Credit: Prepaid Insurance

Key Concepts

Understanding Accrued Revenue

Accrued revenue refers to the income earned by a company for goods or services that have been delivered or performed, but payment has not yet been received. This type of revenue often requires an adjusting entry because it must be recorded during the accounting period in which it is earned, not when the cash is actually received.
To record accrued revenue, the company will make an entry that involves:

• Debiting the Accounts Receivable account to reflect the amount owed by clients.
• Crediting the appropriate Revenue account, such as Service Revenue, to increase its balance.

An example of accrued revenue is a consulting service provided in December, but the client will not pay until January. Despite the payment occurring in the next period, the revenue is recognized in December. This approach ensures the financial statements accurately reflect the company's financial position at any given time.

Explaining Deferred Expenses

Deferred expenses, often known as prepaid expenses, are costs that a company pays in advance for goods or services to be received in the future. These expenses are initially recorded as assets on the balance sheet because they represent a future economic benefit to the company. As the service is consumed, the prepaid expense is gradually converted into an expense on the income statement.
To adjust deferred expenses:

• Debit the applicable Expense account to reflect the consumption of the asset (e.g., Insurance Expense).
• Credit the Prepaid Expense account to decrease the asset's balance (e.g., Prepaid Insurance).

Consider insurance paid for a whole year in advance. Each month, an adjusting entry is made to allocate a portion of the prepaid amount to the expense account, ensuring that expenses are reported in the same period that the related benefits are received.

The Role of a Trial Balance

A trial balance is a worksheet where all the balances from ledger accounts are compiled into Debit and Credit columns. It serves as a preliminary check that the bookkeeping entries are mathematically correct. While a trial balance does not catch all errors, it ensures the sum of debits equals credits, providing a basis to prepare adjusting entries and financial statements.
The trial balance helps in:

• Identifying accounts that require adjustments, such as accrued revenues or deferred expenses.
• Confirming that each financial transaction has been recorded accurately across the accounting period.
• Acting as a bridge to the preparation of financial statements, highlighting inconsistencies needing resolving through adjustments.

By reviewing the trial balance, accountants can efficiently ensure that all necessary adjustments are made before the period’s financial statements are finalized.