4.15. Analysis of interest payable and expense adjusting entry

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

Adjustment No. 1: On June 1, 20X6 Huske's Consultants borrowed \$4,000 cash from the bank and agreed to repay the loan in a year and pay 7% annual interest (see Event No. 5). For the current accounting period, the interest expense amounted to \$163 = \$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 (by increasing Interest Expense) is recorded as a debit:

Illustration 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 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

4.16. Analysis of prepaid rent adjusting entry

Adjustment No. 2: On June 1, 20X6 Huske's Consultants prepaid rent for 12 months in amount of \$2,400 (see Event No. 6). The rent expense to be recognized at the end of the period is calculated as follows: \$1,400 = \$2,400 x (7 months ÷ 12 months). 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 (by increasing Rent Expense) is recorded as a debit:

Illustration 32: Effect of rent expense in T accounts

 Assets = Liabilities + Equity Prepaid Rent Rent Expense Credit (A2) - 1,400 Debit + Expense [- Equity] (A2) - 1,400

This is an asset use transaction:

Illustration 33: Effect of rent expense in the horizontal model

 Assets = Liabilities + Equity Rev. - Exp. = Net Inc. Cash Flow (1,400) = n/a + (1,400) n/a - (1,400) = (1,400) n/a

4.17. Analysis of unearned and earned revenue adjusting entry

Adjustment No. 3: On June 30, 20X6 Huske's Consultants received a \$3,600 advance cash payment for services to be performed within a year starting on July 1, 20X6 (see Event No. 8). By December 31, 20X6 the company had provided 6 months of service, so the amount to be recorded as revenue is \$1,800 = \$3,600 x (6 months ÷ 12 months). 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 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

This is a claims exchange transaction:

Illustration 35: Effect of revenue recognition in the horizontal model

 Assets = Liabilities + Equity Rev. - Exp. = Net Inc. Cash Flow n/a = (1,800) + 1,800 1,800 - n/a = 1,800 n/a
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