Question

A company has a fiscal year-end of December 31: (1) on October 1, $22,000 was paid for a one-year fire insurance policy; (2) on June 30 the company lent its chief financial officer $20,000; principal and interest at 6% are due in one year; and (3) equipment costing $70,000 was purchased at the beginning of the year for cash. Depreciation on the equipment is $14,000 per year.

If the adjusting entries were not recorded, would net income be higher or lower and by how much?
  

Answer 1

Answer

• Working

Adjustment #	Adjustment amount	Working/Explanation
#1 [Insurance expense]	$5,500	$ 22000 is for 12 months. Period till 31 Dec from 1 Oct = 3 months. 3 months Insurance expense = 22000 x 3/12 = 5500
#2 [Interest Revenue]	($600)	6 month interest, from 1 Jul to 31 dec = 20000 x 6% x 6/12 = 600 = Interest Revenue
#3 [Depreciation expense]	$14,000
Total	$18,900

• Hence, if they are NOT RECORDED, Net Income would be HIGHER by $ 18,900