Accounting: Income Statement and Prepaid Insurance

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ACC501: COMPUTERISED ACCOUNTING TUTORIAL 4

DISCUSSION QUESTIONS

i. ‘Why are adjusting entries necessary? Surely they cause too much delay in preparing financial statements, and the financial effect of any entries made is immaterial in the long run.’ Respond to this criticism.

ii. The owner of a business reviews the income statement prepared by you and asks, “Why do you report a profit of only $30 000 when cash collections of $100 000 were received and cash payments for the period totalled only $50 000 for expenses?” How would you respond to the owner’s question?

iii. On 31 March, Padbury Publishers received a subscription of $240 for the supply of twelve monthly magazines, beginning in April. At the end of the reporting period, 30 June, the accountant suggested that the owner make an adjusting entry to defer the revenue on nine issues until the new year. The owner of the business was reluctant to do so, claiming that he had already received the subscriptions in cash and could see no reason for the delay in recognising the revenue. Do you agree with the owner or the accountant? Respond to the owner, explaining the accountant’s position.

iv. “The income statement and balance sheet contain only past information, and therefore are not very relevant for decision making.” Discuss.

Exercise

Adjusting entry for Prepaid Insurance

Windy Saloons purchased a 3 year insurance policy on 1 st October 2010. The entire premium of $5000 was recorded by debiting Prepaid Insurance. Required A. Give the adjusting entry at 30 June for year ending 30 June 2011. B. What amount should be reported in the 30 June 2011 balance sheet for Prepaid Insurance? C. If no adjusting entry was made on 30 June, by how much would profit be overstated or understated? Would assets be overstated or understated? D. Give the adjusting entry at 30 June 2012. E. What would your adjusting entry in requirement A be if the premium of $5 000 was recorded by debiting Insurance Expense?...
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