Question

During the course of your examination of the financial statements of Trojan Corporation for the year ended December 31, 2021, you come across several items needing further consideration. Currently, net income is $92,000. 1. An insurance policy covering 12 months was purchased on October 1, 2021, for $19,200. The entire amount was debited to Prepaid Insurance and no adjusting entry was made for this item in 2021. 2. During 2021, the company received a $3,200 cash advance from a customer for services to be performed in 2022. The $3,200 was incorrectly credited to Service Revenue. 3. There were no supplies listed in the balance sheet under assets. However, you discover that supplies costing $2,350 were on hand at December 31, 2021. 4. Trojan borrowed $62,000 from a local bank on September 1, 2021. Principal and interest at 12% will be paid on August 31, 2022. No accrual was made for interest in 2021. Required: Using the information in 1 through 4 above, determine the proper amount of net income as of December 31, 2021. (Do not round intermediate calculations. Amounts to be deducted should be indicated with a minus sign.) Net income (unadjusted) 1. Adjustment for insurance 2. Adjustment for deferred revenue 3. Adjustment for supplies 4. Adjustment for interest Net income (adjusted)

Answer 1

1. 3 months of insurance have expired (October 1 - December 31). An adjusting entry should be made on December 31, 2021 for the expired 3 months of insurance.

$19,200 / 12 = $1,600 per month

$1,600 x 3 = $4,800 of insurance expired. A related expense should be recognized.

End result: Income decreases by $4,800

2. No revenue should be recognized. The entire $3,200 should be reversed subtracted from net income to correct total revenues.

End result: Income decreases by $3,200.

3. Assuming the balance sheet is indeed 'balanced' (meaning cash balance is also correct) and supplies are not listed, then it is safe to assume that the initial entry for purchasing this supplies is a debit to Supplies Expense and a credit to Cash.

Since there is no adjustment for the remaining supplies, Supplies Expense is overstated. To correct for this, we debit Supplies and credit Supplies Expense for $2,350.

End result: Income increases by $2,350.

4. 4 months (September 1 - December 31) of interest should be accrued. Computations:

Interest Expense (4 months) = principal x rate x time

= $62, 000 x 12% x (4/12)

= $2,480

End result: Income decreases by $2,480

Computations:

Unadjusted balance                                    $92,000

a. Recognize Insurance Expense      (4,800)

b. Reverse Service Revenue               (3,200)

c. Reverse Supplies Expense                 2,350

d. Recognize Interest Expense          (2,480)

Adjusted balance                                  $83,870