A.3. Accruals And Deferrals

Explanation
Under accrual accounting, events that change an entity’s financial position are recorded in the period in which the events occur. This means revenues are recognized when earned rather than when cash is received, and expenses are recognized when incurred rather than when cash is paid. Therefore, when the royalties are paid, Wand should debit an asset account (prepaid royalties) rather than an expense account. The royalties paid should be reported as expense in the period incurred (by debiting royalty expense and crediting prepaid royalties).

Explanation
The balance in the advertising expense account on 12/31/10 before adjustment is $146,000. Since the sales promotional campaign is to be conducted in January, any associated costs are an expense of 2011. Thus, the $15,000 cost of printing catalogs should be removed from the advertising expense account and recorded as a prepaid expense as of 12/31/10. In addition, advertising expense must be increased by the $9,000 cost of December’s radio advertisements, which are an expense of 2010 even though they were not billed to Clark or paid until 2011. The $9,000 must be accrued as an expense and a liability at 12/31/10. Therefore, 2010 advertising expense should total $140,000 ($146,000 – $15,000 + $9,000).

Explanation
The opening balance in prepaid expenses ($1,500) results from a one-year insurance premium paid on 7/1/09. Since this policy would have expired by 6/30/10, no part of the $1,500 is included in 12/31/10 prepaid expenses. The insurance premium paid on 7/1/10 ($3,200) would be partially expired (6/12) by 12/31/10. The remainder (6/12 × $3,200 = $1,600) would be a prepaid expense at year-end. The entire advance rental payment ($2,000) is a prepaid expense at 12/31/10 because it applies to 2011. Therefore, total 12/31/10 prepaid expenses are $3,600. Prepaid insurance ($3,200 × 6/12) $1,600 Prepaid rent 2,000 Total prepaid expenses $3,600

Explanation
Apparently Roro records policy payments as charges to insurance expense and records prepaid insurance at the end of the quarter through an adjusting entry. The unadjusted trial balance amounts at 3/31/10 must represent the final two months of the old policy ($300 of prepaid insurance) and the cost of the new policy ($7,200 of insurance expense). An adjusting entry must be prepared to reflect the correct 3/31/10 balances. Since the new policy has been in force one month (3/1 through 3/31), thirty-five months remain unexpired. Therefore, the balance in prepaid insurance should be $7,000 ($7,200 × 35/36). Insurance expense should include the cost of the last two months of the old policy and the first month of the new policy [$300 + ($7,200 × 1/36) = $500]. Roro’s adjusting entry would transfer $6,700 from insurance expense to prepaid insurance to result in the correct balances.

Explanation
At 12/31/10, the liability account unearned subscription revenue should have a balance which reflects all unexpired subscriptions. Of the 2009 sales, $125,000 expires during 2011 and would still be a liability at 12/31/10. Of the 2010 sales, $340,000 ($200,000 + $140,000) expires during 2011 and 2012, and therefore is a liability at 12/31/10. Therefore, the total liability is $465,000 ($125,000 + $340,000). This amount would have to be removed from the sales account and recorded as a liability in a 12/31/10 adjusting entry.