Review of employees' wages: on December 31, $500 of wages are owed to employees for work they did in December.

Companies usually pay their employees after they work for the companies rather than before they work. It is quite common for companies to pay their employees one or two weeks after the employees' work is completed. One result of this policy is that companies' balance sheets usually report liabilities for wages earned by employees but not paid to them. The Guitar Lessons Corporation's December 31 unadjusted trial balance does not report a liability for unpaid employee wages. This suggests the company does not owe any wages to its employees on December 31. If, as part of the review process, management examines the company's employees' work records and determines that the company owes its employees $500 for services they provided to the company in December but for which they were not paid, what does this suggest about the company and the company's unadjusted trial balance data?

If management's review reveals that the company owes its employees wages of $500 on December 31, it should report a $500 liability on its trial balance. Thus, the December 31 $0 liability for wages payable must be changed, or adjusted, to the more reasonable $500.

Since the unadjusted trial balance reported wages payable of $0 but management's review revealed a liability of $500, what caused this $500 wages payable liability? As discussed above, employees provide services to companies. As services are provided by employees, the services are used up by the companies. Thus, the $500 wages payable was caused by employees providing services to the Guitar Lessons Corporation and the company using up the services. The using up of employee services is recognized as a decrease in stockholders' equity because management has used up some resources: the services provided by employees. The specific stockholders' equity account affected is wages expense, as shown below.

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

$14,900

=

$2,150

+

$7,000

+

$5,750

 

 

+ $500
wages payable

 

 

+

- $500
wages expense

$14,900

=

$2,650

+

$7,000

+

$5,250

Remembering (1) in each journal entry the total dollar amount of debits must equal the total dollar amount of credits and (2) assets increase with debits, how is the December 31 employee wages adjusting entry recorded in the general journal?

Since wages payable is a liability and liabilities increase through credits, the $500 increase in wages payable would be recorded as a $500 credit to wages payable. The required debit of $500 would be to wages expense. Wages expense is debited because management's using up of resources reduced stockholders' equity. Since stockholders' equity increases with credits, it must decrease with debits. If you also remember from previous chapters that expenses increase with debits, you support this debit to wages expense because wages expense did increase by $500. This event would be recorded in the general journal as follows.

Date

Description

Post.
Ref.

Debits

Credits

Dec. 31

Wages Expense

517

500

 

 

     Wages Payable

214

 

500

 

December wages

 

 

 

As a result of the above entry, the adjusted balance in wages payable is $500. This $500 balance represents the $500 the company owes its employees on December 31. The adjusted balance in wages expense is $1,400 ($900 unadjusted debit balance + $500 debit in the above adjusting entry). This $1,400 represents the total dollar amount of employees' services used up by the company in December. $900 of the employees' services used up were recorded by the company earlier in December and $500 were recorded through the above adjusting entry.


Practice Exercise

On August 31, the Christopher Corporation's unadjusted trial balance included prepaid insurance of $1,200 and insurance expense of $0. During August, the company had paid $1,200 for fire insurance protection for the four months August through November.

1. Determine the company's insurance expense for August.

The company's $1,200 payment for four months' fire insurance protection means the company's insurance expense per month should be $300.

2. Determine the adjusted balance in the company's prepaid insurance account on August 31.

At the end of August, the company will have used up protection of $300 (insurance expense) and should have $900 protection left (prepaid insurance). The $900 prepaid insurance balance on August 31 represents fire protection of $300 per month for September, October, and November.

3. Record the proper insurance adjusting entry required on August 31 (in this exercise, ignore the post. ref. column). Before you prepare the journal entry, determine the transaction's effects on the company's resources and sources of the resources.

The company's $1,200 payment for four months' fire insurance protection means the company's insurance expense per month should be $300. At the end of August, the company will have used up protection of $300 (insurance expense) and should have $900 protection left (prepaid insurance). Since the unadjusted prepaid insurance balance is $1,200, using up $300 of protection will reduce the company's resources and sources of resources as follows.

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

- $300
prepaid insurance

=

 

 

 

 

- $300
insurance expense

Assets (resources) increase with debits and decrease with credits. Thus, the $300 decrease in the prepaid insurance asset would be recorded as a credit. The debits = credits rule requires a $300 debit to some other account. In this case the $300 debit is to insurance expense.

Date

Description

Post.
Ref.

Debits

Credits

Aug. 31

Insurance Expense

 

300

 

 

     Prepaid Insurance

 

 

300

 

August insurance

 

 

 

4. Determine the adjusted balance in the company's prepaid insurance account on September 30.

By the end of September, the company will have used up protection of $600 ($300 insurance expense in August and $300 insurance expense in September) and should have $600 protection left (prepaid insurance). The $600 balance in prepaid insurance on September 30 represents $300 of protection for October and $300 of protection for November.


** You now have the background to do text exercise 4.9.

 

 

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