Question

Christie Zimmerman is the chief accountant of GG Industries, a large manufacturing company. In addition to its normal business activities, the company has excess warehouse space that it rents out to local businesses. Because the typical renter is a small business, GG Industries requires renters to make lease payments for the entire rental period on the day the lease is signed. As a result, GG Industries typically reports a large unearned rent balance on its balance sheet (a liability). After making adjusting entries for the current year, Christie prepares the adjusted trial balance and notices that the company's earnings have declined significantly. When she presents the adjusted trial balance to the company's CEO, he becomes very concerned about the decline of the earnings. He notices the large unearned rent balance and proposes making an additional end-of-period adjusting entry to record the entire unearned rent balance as earned revenue in the current period. Christie is not in agreement with Mr. Gance's suggestion since the adjusting entry to record the portion of unearned rent that has already been made, and that all account balances are correct in the adjusted trial balance. Mr. Gance insists that Christie make the additional adjustment, saying: "we have already received the cash, we have the right to recognize the revenue in the current period."

How should this situation be handled? Should the additional adjusting entry be made? Be sure to support your answer with details and examples.

Answer 1

1. The additional adjusting entry should not be made and if it is made, it will be in non compliance of the accrual concept. Which says that revenue and expenses should be recognised in the year of actual occurence and not when actually the payment is made or received.
2. Gance's suggestion as to make an additional adjusting entry as the cash is already received for the recognition of unearned rent revenue is not correct and chief accountant's argument will be genuine.
3. Example, recording of cost of goods sold relating to the entire sales is recorded in the same period, expenses are recorded when they are incurred and not when they are paid.
4. So the adjusting entry should not be made and the CEO justification has no base.