Plex Paintball records adjusting entries on an annual basis. The company has the following information available on accruals that must be recorded for the year ended May 31, 2017. 1. Plex Paintball has a 4% note payable with its bank for $48,000. Interest is payable on a monthly basis on the first of the month. 2. Plex Paintball is open seven days a week and employees are paid a total of $3,500 every Monday for a seven-day (Monday-Sunday) workweek. May 31, 2017, is a Wednesday so employees will have worked three days (Monday-Wednesday) before the year end that they have not been paid for as at May 31. Employees will be paid next on Monday, June 5, 2017. 3. Plex Paintball receives a commission from Pizza Shop next door for all pizzas sold to customers using the Plex Paintball facility. The amount owing for May is $520, which Pizza Shop will pay on June 7, 2017. 4. The May utility bill for $425 was unrecorded on May 31. Plex Paintball paid the bill on June 9, 2017. 5. Plex Paintball sold some equipment on May 1, 2017, in exchange for a $6,000, 6% note receivable. The principal and interest are due on August 1, 2017. Instructions (a) For each of the above items, prepare the adjusting entry required at May 31, 2017. (b) For each of the above items, prepare the journal entry to record the related cash transaction in 2018. Assume all payments and receipts are made as indicated.
The Correct Answer and Explanation is :
(a) Adjusting Entries at May 31, 2017:
- Interest on Note Payable
- Plex Paintball owes interest on the $48,000 note payable at 4% annual interest. Since interest is payable monthly, we need to calculate the interest accrued for May (one month).
- Interest = Principal × Rate × Time = $48,000 × 4% × (1/12) = $160. Adjusting Entry:
- Debit: Interest Expense $160
- Credit: Interest Payable $160
- Accrued Wages
- Employees are paid $3,500 every Monday for a seven-day workweek, but as of May 31, only three days (Monday-Wednesday) have been worked in the new pay period, so wages need to be accrued for these three days.
- Wages per day = $3,500 / 7 = $500
- Wages accrued for 3 days = $500 × 3 = $1,500. Adjusting Entry:
- Debit: Wages Expense $1,500
- Credit: Wages Payable $1,500
- Commission Receivable from Pizza Shop
- Plex Paintball is owed a commission of $520 for May, to be received on June 7, 2017. Adjusting Entry:
- Debit: Accounts Receivable $520
- Credit: Commission Revenue $520
- Accrued Utility Expense
- The utility bill of $425 has not been recorded as of May 31 and will be paid on June 9, 2017. Adjusting Entry:
- Debit: Utility Expense $425
- Credit: Accounts Payable $425
- Interest on Note Receivable
- Plex Paintball sold equipment and is due interest on a $6,000 note at 6% annual interest. Since the note is for three months (May 1 – August 1), we need to accrue the interest for May (one month).
- Interest = Principal × Rate × Time = $6,000 × 6% × (1/12) = $30. Adjusting Entry:
- Debit: Interest Receivable $30
- Credit: Interest Revenue $30
(b) Journal Entries for Cash Transactions in 2018:
- Interest Payment on Note Payable
- Interest payable of $160 is paid on June 1, 2017. Journal Entry:
- Debit: Interest Payable $160
- Credit: Cash $160
- Payment of Accrued Wages
- The employees are paid their accrued wages on June 5, 2017, for the period worked from May 29 to June 4. Journal Entry:
- Debit: Wages Payable $1,500
- Credit: Cash $1,500
- Receipt of Commission from Pizza Shop
- Plex Paintball receives the $520 commission from Pizza Shop on June 7, 2017. Journal Entry:
- Debit: Cash $520
- Credit: Accounts Receivable $520
- Payment of Utility Bill
- The utility bill of $425 is paid on June 9, 2017. Journal Entry:
- Debit: Accounts Payable $425
- Credit: Cash $425
- Receipt of Principal and Interest on Note Receivable
- Plex Paintball receives the $6,000 principal and $30 interest on August 1, 2017. Journal Entry:
- Debit: Cash $6,030
- Credit: Notes Receivable $6,000
- Credit: Interest Receivable $30
Explanation:
- Interest on Note Payable: Interest must be accrued for the month since it is payable monthly. This adjusting entry ensures that the interest expense is matched to the correct accounting period.
- Accrued Wages: The wages earned by employees but not yet paid must be accrued. This entry ensures that the expense is recognized in the period in which it was incurred, even though payment will occur later.
- Commission Receivable: The commission owed by the Pizza Shop is recorded as a receivable, as it is earned but will not be received until June. This adjusting entry ensures that revenue is recognized in the period when earned.
- Accrued Utility Expense: The utility bill must be recorded as an expense even though it has not yet been paid, ensuring that the company’s expenses are properly matched with the period in which they were incurred.
- Interest on Note Receivable: Interest earned on the note receivable must be accrued for the month of May. This ensures that the revenue is recorded in the period it is earned, even though the payment will be received later.
In the cash transaction entries, the company recognizes payments and receipts as they occur in the following periods, clearing out liabilities and recognizing cash flows.