Question

Duluth Co. collected a $6,000 cash advance from a customer on November 1, 2016 for work to be performed over a six-month period beginning on that date. If the year-end adjustment is properly recorded, what will be the effect of the adjusting entry on Duluth's 2016 financial statements?a. Increase assests and decrease liabilitiesb. Increase assests and increase revenuesc. Decrease liabilities and increase revenuesd. No effect

Answer 1

Answer:

c. Decrease liabilities and increase revenues.

Explanation:

Duluth Co. collected a $6,000 cash advance from a customer on November 1, 2016 for work to be performed over a six-month period beginning on that date.

If the year-end adjustment is properly recorded, the effect of the adjusting entry on Duluth's 2016 financial statements will be a decrease in liabilities and increase in revenues.

This will be the case because when Duluth Co. collected a $6,000 cash advance from a customer on November 1, it would have passed the following entries:

Dr Cash................$6000

Cr Prepaid Revenue...$6000

But note that 'prepaid revenue' is a liability which is why it has a credit balance.

By year end, the adjustment will be to take credit to revenue for 2 months that has elapsed for November and December, which is 2/6 x $6000.

Hence the entry will be:

Dr. Prepaid Revenue.....$2000

Cr. Revenue....................................$2000

which implies that the liability of prepaid revenue has reduced and revenue has increased