Question

During the course of your examination of the financial statements of the Hales Corporation for the year ended December 31, 2021, you discover the following:
1) An insurance policy covering three years was purchased on January 1, 2021, for $5,400. The entire amount was debited to insurance expense and no adjusting entry was recorded for this item.
2) During 2021, the company received a $775 cash advance from a customer for merchandise to be manufactured and shipped in 2022. The $775 was credited to sales revenue. No entry was recorded for the cost of merchandise.
3) There were no supplies listed in the balance sheet under assets. However, you discover that supplies costing $795 were on hand at December 31.
4) Hales borrowed $22,000 from a local bank on October 1, 2021. Principal and interest at 12% will be paid on September 30, 2022. No accrual was recorded for interest.
5) Net income reported in the 2021 income statement is $37,000 before reflecting any of the above items.
Required:
Determine the proper amount of net income for 2021. (Amounts to be deducted should be indicated by a minus sign.)

Answer 1

Answer:

$39,960

Explanation:

Considering all the transactions recorded;

When insurance is paid in advance, the entries required are  

Debit Prepaid Insurance

Credit Cash account

As time elapses and the insurance expires,

Debit Insurance expense

As such amount that should have been posted to insurance expense

= $5400/3

= $1800

Adjustment required

= $5400 - $1800

= $3600

When a fee is received in advance for a service yet to be rendered, the revenue for such fee is said to be unearned. The entries required are

Debit Cash account and Credit Unearned fees or deferred revenue.

As the service is performed and the revenue is earned, debit Unearned fees and credit revenue.

Hence the revenue will be deducted ($775).

When the inventory closing balance is understated, the cost of goods sold is overstated and as such the net income which is posted to the retained earnings will be understated . $795

Interest expense to be recognized

= 12% * 3/12 * $22,000

= $660

the proper amount of net income for 2021

= $37,000 - $660 - $775 + $3600 + $795

= $39,960