Let's now look at numbers 17 through 22. These reflect some situations that Mary Jo is considering recording adjusting entries for and we need to help her decide whether or not we need to record anything. In transaction 17 or number 17, Mary Jo is contemplating whether or not she needs to record depreciation on the truck and the equipment as she did in the first year and we know enough at this point to know that the answer to that is yes. So she's going to record a left-hand side or a debit to retained earnings and make a note that, that's depreciation expense and then she'll record a right-hand side or a credit to each of the two asset accounts that she's depreciating and remember she sold some of the equipment during this particular year. And so, she will be recording less depreciation expense in year two on the equipment that she did in year one. The equipment that she sold, she had been recording $200,000 per year in depreciation. So instead of $2,000 of depreciation expense on the equipment this year, she will record only $1,800 of depreciation expense. So, the total depreciation expense that we show in the retained earnings account is $4,200. 1,800 of that is a reduction of the equipment account. 2,400 is a reduction to the truck account. Good, let's move to transaction 18. Did she need to record depreciation on the land she had purchased during the year? Interestingly, land is not depreciated, because it is assumed to have an unlimited useful life. So, Mary Jo does not need to record any entry to depreciate the land. Did she need to record any interest expense on the loan that she had obtained to help finance the purchase of the land? Well, this is an intriguing question. Let's think about that. Let me draw a timeline here, so we can think about the sequence of events that have happened related to this loan. She took out the loan to purchase the land on July 1st of this second year of operations. She makes her first payment to the bank on June 30th in the following year and the third year of operations. That loan payment will be part principal and part interest. Remember, this was a $90,000 loan and so the principal payment that she will be making next year is $9,000. The interest payment that she will make will be $7,200, because it was an 8% interest rate on a $90,000 loan. So those are the facts, that's what we know. Well, we're sitting here at this point, getting ready to prepare financial statements. And we're wondering whether or not we need to record anything before we can prepare those financial statements. Let's record an adjusting entry for one-half of the year's interest. Recall the matching principle. We need to record all costs associated with generating revenue during this particular year. At the same time, we're recording the revenues or in the same accounting period, we're recording the revenues. One of the costs that we've incurred this year to generate those revenues is the cost of borrowing money from the bank. And so, that cost needs to be matched against the revenues that will show up on the financial statements this period. So, we have half a year's interest that we're going to record. So our 7,200 year's worth of interest, we'll record half of that as an expense, as an adjusting entry this period. You might recognize that from our earlier discussions is what we call an accrued expense. We are recording an expense now and the cash payment will take place in the future. So the entry that we will record is a left-hand or a debit to retained earnings with a notation of interest expense for $3,600 and a right-hand side to interest payable, which is a liability for $3,600. Recall we didn't make the interest payment, but now we have an obligation to pay the $3,600 that we have accrued this particular year. Let's move to transaction 20. Does she need to make any adjustments to the prepaid advertising account? This could be thought up in a simpler situation, let's take at, put our timeline here. She purchased advertising on July 1st of this year and she purchased a years worth of advertising, so that advertising campaign will run for one year. Remember that on July 1st when she bought the advertising, she recorded a prepaid expense asset on the books. Here, we set that December 31st. We're getting ready to prepare the financial statements. Do we need to record anything to represent the using up of that advertising for these six months? Yes, we do. So, we need to record an adjusting entry. For one-half years advertising. She paid $5,000 when she bought the advertising on July 1st. We need to record an expense for 2,500 of that to capture that we're using up that asset. So the left-hand side or a debit to retain earnings for 2,500 will reduce the balance in the prepaid advertising account by 2,500, because we've used that much of the asset. Did she need to make any adjustments to the deferred revenue account? Number 21, well let's think about that. With this particular situation, we had a customer that Came to the Garden Spot on November 30th and paid the Garden Spot $10,000 in cash for plants that would be delivered in February of the following year. At this point in time, we reported an increase in cash and an increase in the deferred revenue liability. The question at hand is before we prepare the financial statements, do we need to record any adjusting entry to capture the earned portion of revenue between November 30th and December 31st? Well let's think about that if we had earned any revenue during that period, yes we would record that adjusting entry to capture that earned portion of revenue. However, we're not going to earn any of that revenue until the month of February and the following year when the Garden Spot delivers plants to the customer. So here, there's no adjusting entry being made, because we haven't earned any of the revenue as of the end of the year. Transaction 22, did she need to record anything related to this year's income taxes? Remember, she has an income tax rate of 15%, but she decided this year, she wasn't going to pay taxes on the last day of the year. She would wait until April 15th of the following year when they were technically due to the tax authorities to make that payment. Does she need to record any expense? Absolutely. She needs to record a year's worth of tax expense to match the expense against the revenues that those taxes are associated with. So if we pull-up our retained earnings to your account, we can make a calculation of the taxes that she owes. We know the revenues. We know all of the expenses, Before tax expense. So, we can calculate the earnings that the Garden Spot has before taxes. $500,000 of revenue. These expenses here that I have circled in T account total of $465,500, you could check my math on that if you'd like. And so the earnings before any taxes, I'll call that E for earnings, B for before, T for taxes. Earnings before taxes are $34,500. The company has a 15% tax rate. So, the taxes owed of 5,175. Pretty simple calculation. We can get all our information for the retained earnings T account, which has been so handy to us previously. So, let's record that entry. We have a left-hand side to retained earnings for tax expense and a right-hand side to a taxes payable liability. Remember, she's not paying the taxes. And this year, she's going to pay them in the future in next April. So, she has to go ahead and record that liability to indicate or to capture how much she owes to the tax authorities.
