No.2 FA Assignment 3 Amato FIX

2.
Accounting, Analysis, and Principles
The Amato Theater is nearing the end of the year and is preparing for a meeting with its bankers
to discuss the renewal of a loan. The accounts listed appeared in the December 31, 2015, trial
balance as follows:
Debit Credit
Prepaid Advertising £ 6,000
Equipment 192,000
Accumulated Depreciation—Equipment £ 60,000
Notes Payable 90,000
Unearned Service Revenue 17,500
Service Revenue 360,000
Advertising Expense 18,680
Salaries and Wages Expense 67,600
Interest Expense 1,400
Additional information is available as follows.

1. The equipment has an estimated useful life of 16 years and a residual value of £40,000 at the
end of that time. Amato uses the straight-line method for depreciation.
2. The note payable is a one-year note given to the bank January 31 and bearing interest at 10%.
Interest is calculated on a monthly basis.
3. The theater sold 350 coupon ticket books at £50 each. Two hundred ticket books were used in
2015. One hundred fifty of these ticket books can be used only for admission any time after
January 1, 2016. The cash received was recorded as Unearned Service Revenue.
4. Advertising paid in advance was £6,000 and was debited to Prepaid Advertising. The company
has used £2,500 of the advertising as of December 31, 2015.
5. Salaries and wages accrued but unpaid at December 31, 2015, were £3,500.
Accounting
Prepare any adjusting journal entries necessary for the year ended December 31, 2015.
Answer:
Date Accounts and Explanation Debit (£) Credit (£)

31 Dec 2015 Depreciation Expense 9,500
(Cost- Residual value) ÷ Useful life
= (£192,000 – £40,000) ÷ 16 = £9,500
Accumulated Depreciation—Equipment 9,500
31 Dec 2015 Interest Expense 8,250

Interest Payable 8,250
(£90,000 x 10%) x 11/12 = £8,250)
31 Dec 2015 Unearned Service Revenue 10,000

Service Revenue 10,000
200 x £50 = £10,000
31 Dec 2015 Advertising Expense 2,500
Prepaid Advertising 2,500
31 Dec 2015 Salaries and Wages Expense 3,500

Salaries and Wages Payable 3,500
£33,750 £33,750
 Both sides of the journal total $33,750.

 The net income of the business entity is overstated when adjusting entries are not made.
 Reporting financial information frequently to users will increase the relevance of the financial
statements.
Analysis
Determine Amato’s income before and after recording the adjusting entries. Use your analysis to
explain why Amato’s bankers should be willing to wait for Amato to complete its year-end
adjustment process before making a decision on the loan renewal.
Answer:
Income before Income after

Adjustments Adjustments Adjustments
Service revenue £360,000 £10,000 £370,000
Depreciation expense (9,500) (9,500)
Advertising expense (18,680) (2,500) (21,180)
Salaries and Wages expense (67,600) (3,500) (71,100)
Interest expense (1,400) (8,250) (9,650)
Net income £272,320 £258,570
The loan is provided based on the liquidity position of the business entity. The adjusting
entries would correct the misstated balance of the current assets and liabilities. Therefore, the
bankers should wait for year-end adjustments.
Without recording the adjusting entries, Amato’s income is overstated. In addition, without the
adjustments, Amato’s current liabilities and current assets are misstated, which could affect
evaluation of Amato’s liquidity.
Adjusting entries are required every time a company, prepares financial statements. Adjusting
Entries In order for revenues to be recorded in the period in which services are performed and for
expenses to be recognized in the period in which they are incurred, companies make adjusting
entries.
The use of adjusting entries makes it possible to report on the statement of financial position
the appropriate assets, liabilities, and equity at the statement date. Adjusting entries also make it
possible to report on the income statement the proper revenues and expenses for the period.
Principles
Although Amato’s bankers are willing to wait for the adjustment process to be completed before
they receive financial information, they would like to receive financial reports more frequently
than annually or even quarterly. What trade-offs, in terms of relevance and faithful
representation, are inherent is preparing financial statements for shorter accounting time periods?
Answer:
The periodicity (or time period) assumption implies that a company can divide its economic
activities into artificial time periods. These time periods vary, but the most common are monthly,
quarterly, and yearly.
The shorter the time period, the more difficult it is to determine the proper net income for the
period. A month’s results usually prove less reliable than a quarter’s results, and a quarter’s
results are likely to be less reliable than a year’s results. Investor desire and demand that a
company quickly process and disseminate information. Yet the quicker a company releases the
information, the more likely the information will include errors.
The problem of defining the time period becomes more serious as product cycles shorten and
products become obsolete more quickly. Many believe that, given technology advances,
companies need to provide more online, real-time financial information to ensure the availability
of relevant information.

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2.

Accounting, Analysis, and Principles

Additional information is available as follows.

Date Accounts and Explanation Debit (£) Credit (£)

31 Dec 2015 Interest Expense 8,250

31 Dec 2015 Unearned Service Revenue 10,000

Prepaid Advertising 2,500

31 Dec 2015 Salaries and Wages Expense 3,500

 Both sides of the journal total $33,750.

Income before Income after

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