For the past 52 years, Harold Averkamp (CPA, MBA) has worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.
Author:
Harold Averkamp, CPA, MBA
For multiple-choice and true/false questions, simply press or click on what you think is the correct answer. For fill-in-the-blank questions, press or click on the blank space provided.
If you have difficulty answering the following questions, learn more about this topic by reading our Adjusting Entries (Explanation).
Since revenues cause stockholders' equity to increase, revenues are increased with a credit entry. [Stockholders' equity appears on the right side of the accounting equation. Credit entries appear on the right side of a T-account.]
What type of entry will increase the normal balance of the general ledger account that reports the amount owed as of the balance sheet date for a company's accrued expenses?
The amount owed for accrued expenses is reported in a liability account such as Accrued Expenses Payable. Since a liability account is expected to have a credit balance, a credit entry will increase the normal balance. [Recall that liabilities are on the right side of the accounting equation. Credit entries appear on the right side of a T-account.]
What type of entry will increase the normal balances of the general ledger accounts Electricity Expense, Insurance Expense, Interest Expense, and Repairs Expense?
Expenses are recorded in expense accounts with a debit entry. The reason is that expenses will cause a decrease in stockholders' (or owner's) equity.
What type of accounts are Interest Receivable and Fees Receivable?Receivables are asset accounts. Assets appear on the left side of the accounting equation and asset accounts will normally have debit balances.
What type of entry will decrease the normal balances of the general ledger accounts Interest Receivable and Fees Receivable?
Receivables normally have debit balances. Therefore, to decrease the debit balance in a receivable account you will need to credit the account.
What type of accounts are Deferred Revenues and Unearned Revenues?Accounts such as Deferred Revenues, Unearned Revenues, and Customer Deposits are liability accounts. As with liability accounts, the normal balance will be a credit balance.
Under the accrual method of accounting, the accounts such as Unearned Revenues are necessary when a company receives money from a customer in advance of the company earning the money. (Since the money has not yet been earned, it cannot be reported as revenues on the income statement.) The liability account communicates that a company has an obligation to provide its customers with goods or services or return the money to the customers.
What type of entry will decrease the normal balances of the accounts Deferred Revenues and Unearned Revenues?
Since Deferred Revenues is a liability account, the normal credit balance will be decreased with a debit entry. For example, when some of the deferred revenues become earned, the company will debit the Deferred Revenues and will credit a revenue account such as Service Revenues.
What type of accounts are Prepaid Insurance, Prepaid Advertising, and Prepaid Expenses?Prepaid expenses that have not been used up or have not yet expired are reported as assets. In other words, prepaid expenses are unexpired costs. When the costs expire (or are used up) they become expenses.
What type of entry will decrease the normal balances of the accounts Prepaid Insurance and Prepaid Expenses, and Insurance Expense?
Since Prepaid Insurance and Prepaid Expenses are asset accounts, their normal debit balance will be decreased with a credit entry.
Since expenses usually have debit balances, Insurance Expense will be decreased with a credit entry.
What type of accounts are Accumulated Depreciation and Allowance for Doubtful Accounts?Contra asset accounts will have credit balances. The word contra indicates the balances in these two accounts will be contrary to the debit balances that are expected in asset accounts.
What type of entry will increase the balances that are normally found in the accounts Accumulated Depreciation and Allowance for Doubtful Accounts?
Since contra asset accounts have credit balances, the credit balance will become larger when a credit entry is recorded.
In the case of a company's accrued interest expense, which of the following occurs first?Incurring the interest expense
An accrued expense is an expense (and a liability) which was incurred by a borrower but the interest has not been recorded.
Paying the interest to the lender
In the case of a bank's accrued interest revenues, which occurs first?Earning the interest revenues
Accrued revenues are recorded because the bank has earned both the interest revenue and a related receivable and neither has yet been recorded by the bank.
Receiving the interest from the borrower
In the case of a company deferring insurance expense, which occurs first?Incurring the insurance expense
Paying the insurance company
Deferred insurance expense is the result of paying the insurance premiums at the start of an insurance coverage period. The amount of insurance premiums that have not expired as of the balance sheet date should be reported in an asset account such as Prepaid Insurance. [As the prepaid insurance premiums expire an adjusting entry should be written to credit the asset Prepaid Insurance and debit Insurance Expense.]
In the case of a company's deferred revenues, which occurs first?Earning the revenues
Receiving the money from the customer
Deferred revenues indicate that a company has received money from a customer before it has been earned.
Which of the following will be included in the adjusting entry to accrue interest expense?A debit to Cash
A credit to Interest Payable
When interest expense has been incurred by a company but no payment has been made and no related paperwork has been processed, the company will need to accrue the interest with a debit to Interest Expense and a credit to Interest Payable.
A debit to Interest Payable
A debit to Prepaid Interest
Which of the following will be included in the adjusting entry to accrue interest income or interest revenues?
A debit to Cash
A debit to Interest Income
A credit to Interest Receivable
A debit to Interest Receivable
When interest has been earned but no cash has been received and no billing paperwork has been processed in the accounting records, a company will need to accrue 1) interest revenue or interest income, and 2) an asset such as Interest Receivable. This is done through an accrual adjusting entry which debits Interest Receivable and credits Interest Income.
The adjusting entry that reduces the balance in Prepaid Insurance will also include which of the following?
A credit to Cash
A credit to Insurance Expense
A debit to Insurance Expense
As the debit balance in the asset account Prepaid Insurance expires, there will need to be an adjusting entry to 1) debit Insurance Expense, and 2) credit Prepaid Insurance.
A debit to Insurance Payable
The adjusting entry that reduces the balance in Deferred Revenues or Unearned Revenues will also include which of the following?
A debit to Cash
A credit to Fees Earned
As the deferred or unearned revenues become earned, the credit balance in the liability account such as Deferred Revenues needs to be reduced. Hence, the adjusting entry to record these earned revenues will include 1) a debit to Deferred Revenues, and 2) a credit to Fees Earned.
A debit to Fees Earned
A credit to Fees Receivable
The ending balance in the account Prepaid Insurance is expected to report which of the following?The accrued amount of insurance expense
The original amount of the insurance premiums paid
The expired portion of the insurance premiums paid
The unexpired portion of the insurance premiums paid
The ending balance in the asset account Prepaid Insurance should be the cost of the insurance premiums that have been paid and which have not yet expired (or have not yet been used up).
The ending balance in the account Deferred Revenues (or Unearned Fees) should report which of the following?
The accrued amount of fees that have been earned
The original amount of fees received in advance from a customer
The fees received in advance which are not yet earned
When customers pay a company in advance, the company credits Unearned Revenues. Then as the company earns some of the revenues, the account Unearned Revenues will be debited and an income statement account such as Service Revenues or Fees Earned will be credited. Thus, the remaining credit balance in Unearned Revenues is the amount received but not yet earned.
The amount of fees received in advance and which are now earned
Which type of adjusting entry is often reversed on the first day of the next accounting period?For example, if a company has incurred commissions expense on December's sales, but will not pay the commissions until January 25, the company will write an accrual type adjusting entry for December’s financial statements. On January 25, the company will write a check to pay those commissions. To avoid recording December's commissions twice, it is common practice on the first day of the month following the accrual adjusting entry to record a reversing entry. (Deferrals do not pose the risk of double counting expenses or revenues.)
Typically an adjusting entry will include which of the following?One balance sheet account and one income statement account
Nearly all adjusting entries involve a minimum of one balance sheet account and a minimum of one income statement account.
Two balance sheet accounts
Two income statement accounts
Use the following information to answer questions 24 – 29:
A company borrowed $100,000 on December 1 by signing a six-month note that specifies interest at an annual percentage rate (APR) of 12%. No interest or principal payment is due until the note matures on May 31. The company prepares financial statements at the end of each calendar month. The following questions pertain to the adjusting entry that should be entered in the company’s records.
$1,000.
Computation:
12% per year is 1% per month X $100,000 = $1,000 per month.
Another method is Principal X Rate X Time = $100,000 X .12 X 1/12 = $1,000.
As of December 31 the company owes just one month of interest. When the note becomes due, the company will have to remit six months of interest for a total of $6,000 ($100,000 X .12 X 6/12).
What would be the effect on the financial statements if the company fails to make the adjusting entry on December 31?
If the company fails to make the December 31 adjusting entry there will be four consequences:
1) Interest Expense will be understated (too little expense being reported) by $1,000.
2) Net Income will be overstated (too much net income being reported) by $1,000.
3) Owner's equity will be overstated by $1,000.
4) Interest Payable will be understated by $1,000.
The accounting equation and balance sheet will show liabilities (Interest Payable) understated by $1,000 and owner's equity overstated by $1,000.
Use the following information to answer questions 30 – 35:
A bank lent $100,000 to a customer on December 1 that required the customer to
pay an annual percentage rate (APR) of 12% on the amount of the loan. The loan is due
in six months and no payment of interest or principal is to be made until the note is due
on May 31. The bank prepares monthly financial statements at the end of each calendar
month. The following questions pertain to the adjusting entry that the bank will be making for its accounting records.
$1,000.
Computation:
12% per year is 1% per month X $100,000 = $1,000 per month.
Another method is Principal X Rate X Time = $100,000 X .12 X 1/12 = $1,000.
As of December 31 the bank has earned just one month of interest. When the note becomes due, the bank will collect six months of interest for a total of $6,000 ($100,000 X .12 X 6/12).
What would be the effect on the financial statements if the bank fails to make the adjusting entry on December 31?
If the bank fails to make the December 31 adjusting entry there will be four consequences:
1) Interest Revenue or Interest Income will be understated by $1,000.
2) Net Income will be understated by $1,000.
3) Owner's equity will be understated by $1,000.
4) Interest Receivable will be understated by $1,000.
The accounting equation and balance sheet will show assets (Interest Receivable) understated by $1,000 and owner's equity understated by $1,000.
Use the following information to answer questions 36 – 41:
On December 1, your company paid its insurance agent $2,400 for the annual insurance premium covering the twelve-month period beginning on December 1. The $2,400 payment was recorded on December 1 with a debit to the current asset Prepaid Insurance and a credit to the current asset Cash. Your company prepares monthly financial statements at the end of each calendar month. The following questions pertain to the adjusting entry that should be written by the company.
A current asset which indicates the cost of the insurance contract (premiums) that have been paid in advance. It represents the amount that has been paid but has not yet expired as of the balance sheet date.
A related account is Insurance Expense, which appears on the income statement. The amount in the Insurance Expense account should report the amount of insurance expense expiring during the period indicated in the heading of the income statement.
A current asset account which includes currency, coins, checking accounts, and undeposited checks received from customers. The amounts must be unrestricted. (Restricted cash should be recorded in a different account.)
What date should be used to record the December adjusting entry? December 31 How many accounts are involved in the adjusting entry? What is the name of the account that will be debited? Insurance Expense (an income statement account) What is the name of the account that will be credited? Prepaid Insurance (a balance sheet account) What is the amount of the debit and the credit?$200.
Calculation:
$2,400 divided by the 12 months of coverage = $200 per month. As of December 31 one month has gone by, so one month of insurance has expired and belongs in expense. This means that the Prepaid Insurance account should have a balance of $2,200 (11 months still prepaid or unexpired X $200 per month).
What would be the effect on the financial statements if the company fails to make the adjusting entry on December 31?
If the company fails to make the December 31 adjusting entry there will be four consequences:
1) Prepaid Insurance will be overstated by $200.
2) Insurance Expense will be understated by $200.
3) Net Income will be overstated by $200.
4) Owner's equity will be overstated by $200.
The accounting equation and balance sheet will show assets (Prepaid Insurance overstated by $200 and owner's equity overstated by $200).
Use the following information to answer questions 42 – 47:
On December 1, your company paid its insurance agent $2,400 for the annual insurance premium covering the twelve-month period beginning on December 1. The $2,400 payment was recorded on December 1 with a debit to the income statement account Insurance Expense and a credit to the current asset Cash. Your company prepares monthly financial statements at the end of each calendar month. The following questions pertain to the adjusting entry that should be written by the company.
The amount of insurance that was incurred/used up/expired during the period of time appearing in the heading of the income statement. The amount of insurance premiums that have not yet expired should be reported in the current asset account Prepaid Insurance.
What date should be used to record the December adjusting entry? December 31 How many accounts are involved in the adjusting entry? What is the name of the account that will be debited? Prepaid Insurance (a balance sheet account) What is the name of the account that will be credited? Insurance Expense (an income statement account) What is the amount of the debit and the credit?$2,200.
Calculation:
$2,400 divided by the 12 months of coverage = $200 per month. As of December 31 one month has gone by, so one month of insurance has expired and belongs in Insurance Expense. Presently there is a $2,400 debit balance in Insurance Expense. To reduce the Insurance Expense to $200 you need to credit Insurance Expense for $2,200. Prepaid Insurance should have a balance of $2,200 because 11 months of insurance is still prepaid or unexpired X $200 per month.
What would be the effect on the financial statements if the company fails to make the adjusting entry on December 31?
If the company fails to make the December 31 adjusting entry there will be four consequences:
1) Prepaid Insurance will be understated by $2,200.
2) Insurance Expense will be overstated by $2,200.
3) Net Income will be understated by $2,200.
4) Owner's Equity will be understated by $2,200.
The accounting equation and balance sheet will show assets (Prepaid Insurance) understated by $2,200 and owner's equity understated by $2,200.
Use the following information to answer questions 48 – 53:
On December 1, XYZ Insurance Co. received $2,400 from your company for the annual insurance premium covering the twelve-month period beginning on December 1. XYZ Insurance Co. recorded the $2,400 receipt as of December 1 with a debit to the current asset Cash and a credit to the current liability Unearned Revenues. XYZ Insurance Co. prepares monthly financial statements at the end of each calendar month. The following questions pertain to the adjusting entry that should be written by the XYZ Insurance Co.
A liability account that reports amounts received in advance of providing goods or services. When the goods or services are provided, this account balance is decreased and a revenue account is increased. To learn more, see Explanation of Adjusting Entries.
What date should be used to record the December adjusting entry? December 31 How many accounts are involved in the adjusting entry? What is the name of the account that will be debited? Unearned Revenues (a balance sheet account) What is the name of the account that will be credited? Service Revenues (an income statement account) What is the amount of the debit and the credit?$200.
Calculation:
$2,400 divided by the 12 months of coverage = $200 per month. As of December 31 one month has gone by, so one month of insurance has been earned and belongs in revenue. This means that the Unearned Revenues account should have a balance of $2,200 (11 months still unearned X $200 per month).
What would be the effect on the financial statements if the company fails to make the adjusting entry on December 31?
If XYZ Insurance Co. fails to make the December 31 adjusting entry there will be four consequences:
1) Unearned Revenues will be overstated by $200.
2) Service Revenues will be understated by $200.
3) Net Income will be understated by $200.
4) Owner's equity will be understated by $200.
The accounting equation and balance sheet will show liabilities (Unearned Revenues) overstated by $200 and owner's equity understated by $200.
Use the following information to answer questions 54 – 59:
On December 1, your company began operations. On December 3 it purchased $1,500 of supplies on credit and recorded the transaction with a debit to the current asset Supplies and a credit to the current liability Accounts Payable. Your company prepares monthly financial statements at the end of each calendar month. At the end of the day on December 31, your company estimated that $700 of the supplies were still on hand in the supply room. The following questions pertain to the adjusting entry that should be entered by your company.
A current asset representing the cost of supplies on hand at a point in time. The account is usually listed on the balance sheet after the Inventory account.
A related account is Supplies Expense, which appears on the income statement. The amount in the Supplies Expense account reports the amounts of supplies that were used during the time interval indicated in the heading of the income statement.
This current liability account will show the amount a company owes for items or services purchased on credit and for which there was not a promissory note. This account is often referred to as trade payables (as opposed to notes payable, interest payable, etc.)
To learn more about accounts payable, see our Accounts Payable Outline.
