# Answered Essay: A company has a fiscal year-end of December 31: (1) on October 1, \$20,000 was paid for a one-year fire insurance policy; (2) on June

A company has a fiscal year-end of December 31: (1) on October 1, \$20,000 was paid for a one-year fire insurance policy; (2) on June 30 the company lent its chief financial officer \$18,000; principal and interest at 8% are due in one year; and (3) equipment costing \$68,000 was purchased at the beginning of the year for cash. Depreciation on the equipment is \$13,600 per year.

If the adjusting entries were not recorded, would net income be higher or lower and by how much?

On October 1, \$20,000 was paid for a one-year fire insurance policy:

\$20,000 Insurance Expense was paid in advance.
Monthly Insurance Expense = \$20,000 ÷ 12 = \$1,666.67
Adjusting entries would be for 3 months = \$1,666.67 × 3 = \$5,000

\$5,000 will be recorded in Income Statement as Expense which will decrease Net Income.

On June 30, the company lent its chief financial officer \$18,000; principal and interest at 8% are due in one year; and

Monthly Interest = (\$18,000 × 8%) ÷ 12 = \$120
Adjusting entries would be \$120 × 6 = \$720

Interest received for 6 month period will be recorded in Income Statement as Revenue and will increase Net Income.

Equipment costing \$68,000 was purchased at the beginning of the year for cash. Depreciation on the equipment is \$13,600 per year.

Depreciation for the year will be recorded in Income Statement as Expense and will decrease Net Income.

The effect of these adjusting entries on Net Income = \$720 – (\$5,000 + \$13,600)
The effect of these adjusting entries on Net Income = -\$17,880

So, If these entries are not recorded then net income will be higher by \$17,880.

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