EZ Curb Company completed the following transactions. The annual accounting period ends December 31. Jan. 8 Purchased merchandise on account at a cost of $14,000. (Assume a perpetual inventory system.) Jan. 17 Paid for the January 8 purchase. Apr. 1 Received $40,000 from National Bank after signing a 12-month, 6 percent, promissory note. June 3 Purchased merchandise on account at a cost of $18,000. July 5 Paid for the June 3 purchase. July 31 Rented out a small office in a building owned by EZ Curb Company and collected six months’ rent in advance, amounting to $6,000. (Use an account called Deferred Revenue.) Dec. 20 Collected $100 cash on account from a customer. Dec. 31 Determined that wages of $6,500 were earned but not yet paid on December 31 (Ignore payroll taxes). Dec. 31 Adjusted the accounts at year-end, relating to interest. Dec. 31 Adjusted the accounts at year-end, relating to rent. Required: For each listed transaction and related adjusting entry, indicate the accounts, amounts, and effects on the accounting equation. For each transaction and related adjusting entry, indicate whether the debt-to-assets ratio is increased or decreased or there is no change. (Assume EZ Curb Company’s debt-to-assets ratio has always been less than 1.0.)

a) Indication of the accounts, amounts, and effects on the accounting equation.

Jan. 8 - Asset (Inventory) and Liabilities (Accounts Payable) are increased with $14,000.

Jan. 17 - Asset (Cash) and Liabilities (Accounts Payable) are decreased with $14,000.

April 1 - Asset (Cash in bank) and Liabilities (Notes Payable) are increased with $40,000.

June 3 -Asset (Inventory) and Liabilities (Accounts Payable) are increased with $18,000.

July 5 - Asset (Cash) and Liabilities (Accounts Payable) are decreased with $18,000.

July 31 - Asset (Cash) and Liabilities (Deferred Revenue) are increased with $6,000.

Dec. 20 - Asset (Cash) is increased by $100 and Asset (Accounts Receivable) are reduced by $100.

Dec. 31 - Liabilities (Wages Payable) is increased with $6,500 and Equity (Retained Earnings) is reduced by $6,500.

Dec. 31 - Liabilities (Interest Payable) are increased by $1,800 and Equity (Retained Earnings) are decreased by $1,800.

Dec, 31 - Liabilities (Deferred Revenue) are reduced by $5,000 and Equity (Retained Earnings) are increased by $5,000.

b) Indication of whether the debt-to-assets ratio is increased or decreased or no change:

Jan 8 - no change, since the two sides are increased by the same amount.

Jan 17 - no change, since the two sides are decreased by the same amount.

Apr 1  - no change, since the two sides are increased by the same amount

June 3 - no change

July 5 - no change

July 31 - no change

Dec 20 - no change

Dec 31 -  the debt-to-asset ratio is increased, because whereas liabilities (Wages Payable) increased by $6,500, there is no corresponding increase in assets.  Instead, there is a reduction in Equity (Retained Earnings) by $6,500.

Dec 31 - for the Interest Payable, the debt to asset ratio is increased because liabilities increased by $1,800 without an increase in assets, but a reduction in Equity (Retained Earnings) by $1,800.

Dec 31 - When Deferred Revenue is adjusted for accrued rent by 5/6 of $6,000, the debt to asset is decreased.  This is because Deferred Revenue (Liabilities) is reduced and Equity (Retained Earnings) is increased without a corresponding effect on the assets side of the equation.

Explanation:

The accounting equation is that Assets = Liabilities + Equity.  Every transaction that affects one side of the equation invariably affects the other side.

If an asset is increased, it may either increase the liabilities or equity side or increase and decrease two accounts on the same side of the equation.

Adjusting for interest on the promisory note of $40,000 at 6% for 9 months gives 6% of $40,000 x 9/12 = $1,800.  It is important to pro rate the interest according to the Accruals concept to record the interest for 9 months only.

The Deferred Revenue (Rent) is also pro rated according to the Accruals concept to recognise the rent received for the period, i.e. for 5 out of 6 months.

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