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Chapter 4 – Exercises & Cases

Multiple Choice Questions​

  1. Adjusting entries are made:
    a) At the beginning of each period
    b) During the period as transactions occur
    c) At the end of each period, before financial statements
    d) Only at year end
    Answer: c) Adjusting entries are made at period end, after regular transactions, before financial statements.

  2. Which type of adjusting entry involves recording an expense and a liability?
    a) Prepaid expense
    b) Unearned revenue
    c) Accrued expense
    d) Accrued revenue
    Answer: c) Accrued expenses record an expense (debit) and a liability (credit).

  3. A business pays €1,200 for 12 months of insurance on January 1. The adjusting entry at the end of January should:
    a) Debit Insurance Expense €100, Credit Prepaid Insurance €100
    b) Debit Prepaid Insurance €100, Credit Insurance Expense €100
    c) Debit Insurance Expense €1,200, Credit Cash €1,200
    d) No entry needed
    Answer: a) One month (€100) of insurance expires and becomes an expense.

  4. Depreciation is recorded as:
    a) A decrease in the asset account
    b) An increase in accumulated depreciation (contra-asset)
    c) A decrease in cash
    d) An increase in revenue
    Answer: b) Depreciation increases accumulated depreciation, a contra-asset account.

  5. In Luxembourg, adjusting entries must:
    a) Be optional
    b) Follow cash basis accounting
    c) Follow accrual basis accounting and PCN standards
    d) Only be made for large businesses
    Answer: c) Luxembourg requires accrual basis accounting and PCN compliance.

  6. An adjusted trial balance is prepared:
    a) Before adjusting entries
    b) After adjusting entries
    c) Instead of adjusting entries
    d) Only at year end
    Answer: b) Adjusted trial balance is prepared after all adjusting entries are made.

  7. Unearned revenue is initially recorded as:
    a) Revenue
    b) An asset
    c) A liability
    d) An expense
    Answer: c) Unearned revenue is a liability because the business owes future services.

  8. Accrued salaries would be recorded as:
    a) Debit Salaries Expense, Credit Cash
    b) Debit Salaries Expense, Credit Salaries Payable
    c) Debit Salaries Payable, Credit Salaries Expense
    d) Debit Cash, Credit Salaries Expense
    Answer: b) Accrued salaries record the expense and the liability to pay.

  9. Which PCN account is used for VAT Payable?
    a) 431000
    b) 430000
    c) 420000
    d) 400000

    Answer: b) 430000 is VAT Payable (Class 4).

  10. Provisions in Luxembourg are classified in PCN:
    a) Class 1
    b) Class 2
    c) Class 4
    d) Class 6
    Answer: a) Provisions are in Class 1 (110000-119999).

Questions​

  1. Explain why adjusting entries are necessary even when all cash transactions have been properly recorded.

  2. Describe the four main types of adjusting entries. Give an example of each type.

  3. What is the difference between a prepaid expense and an accrued expense? How are they recorded differently?

  4. Explain depreciation. Why is it recorded as an adjusting entry, and how does it affect the balance sheet?

  5. What is an adjusted trial balance? How does it differ from an unadjusted trial balance, and why is it important?

  6. How do adjusting entries ensure that financial statements comply with the matching principle and revenue recognition principle?

  7. Explain Luxembourg-specific adjustments for VAT. Why are these adjustments necessary?

  8. Describe how social charges are accrued in Luxembourg. What accounts are involved, and when are these adjustments made?

  9. What are provisions? Give an example of a provision that a Luxembourg business might need to record.

  10. A business pays €6,000 for six months of rent in advance on October 1. What adjusting entry is needed at the end of October? Show the journal entry with PCN account numbers.

Problems Set A​

Problem A-1: Identifying Adjusting Entry Types

For each situation, identify the type of adjusting entry needed:

a) Insurance paid in advance, one month has expired b) Services provided but not yet billed to customer c) Salaries earned by employees but not yet paid d) Cash received in advance for services to be provided next month e) Equipment depreciation for the month

Problem A-2: Prepaid Expenses

A business pays €2,400 for 12 months of rent on January 1. Prepare: a) The initial entry on January 1 b) The adjusting entry at the end of January c) The adjusting entry at the end of February Show PCN account numbers.

Problem A-3: Accrued Expenses

A business has a €10,000 loan at 8% annual interest. Interest is paid quarterly. Prepare the adjusting entry to accrue interest for one month. Show PCN account numbers.

Problem A-4: Unearned Revenue

A business receives €9,000 on September 1 for services to be provided over 3 months. Prepare: a) The initial entry on September 1 b) The adjusting entry at the end of September Show PCN account numbers.

Problem A-5: Depreciation

Equipment costing €24,000 has a useful life of 4 years. Using straight-line depreciation, prepare the monthly adjusting entry. Show PCN account numbers.

Problems Set B​

Problem B-1: Complete Adjustment Process

A Luxembourg business has the following information at the end of November:

  1. Prepaid Insurance: €1,800 paid for 12 months on January 1
  2. Equipment: €36,000 cost, 5-year useful life, straight-line depreciation
  3. Unearned Revenue: €6,000 received for 6 months of services on October 1
  4. Accrued Salaries: €2,000 earned but not yet paid
  5. Accrued Interest: €15,000 loan at 6% annual interest
  6. Supplies: €3,000 on hand, €500 used during November

Prepare all necessary adjusting entries with PCN account numbers.

Problem B-2: Adjusted Trial Balance

Using the unadjusted trial balance and adjusting entries from Problem B-1, prepare an adjusted trial balance. Assume the unadjusted trial balance shows:

  • Prepaid Insurance: €1,800
  • Equipment: €36,000
  • Unearned Revenue: €6,000 (credit)
  • Supplies: €3,000
  • No accumulated depreciation, insurance expense, depreciation expense, or accrued liabilities

Problem B-3: Financial Statements from Adjusted Trial Balance

Using the adjusted trial balance from Problem B-2, prepare: a) Income Statement b) Statement of Owner's Equity (assume beginning equity €50,000, no distributions) c) Balance Sheet

Problem B-4: Luxembourg-Specific Adjustments

A Luxembourg business needs to make the following adjustments at month end:

  1. VAT Payable: €3,400 collected on sales
  2. VAT Recoverable: €1,200 on purchases
  3. Employee social charges: €1,500 (deducted from salaries)
  4. Employer social charges: €1,600
  5. Provision for warranty: €800 estimated

Prepare all adjusting entries with PCN account numbers.

Comprehensive Problem​

Comprehensive Problem 4: Complete Adjustment and Financial Statement Process

Tech Solutions SARL needs to prepare financial statements for the month ended November 30, 2024. The unadjusted trial balance shows:

Tech Solutions SARL
Unadjusted Trial Balance
November 30, 2024

Account                          Debit      Credit
─────────────────────────────────────────────────
510000 Cash                       €25,000
410000 Accounts Receivable         8,000
321000 Inventory                   5,000
460000 Prepaid Insurance           2,400
460000 Prepaid Rent                3,600
223000 Equipment                  40,000
400000 Accounts Payable                    €12,000
430000 VAT Payable                           1,500
470000 Unearned Revenue                     6,000
120000 Bank Loan                              20,000
101000 Share Capital                         30,000
104000 Retained Earnings                     8,000
701000 Service Revenue                       25,000
620000 Salaries Expense          15,000
612000 Rent Expense               1,200
615000 Utilities Expense          2,000
619000 Other Expenses             3,000
─────────────────────────────────────────────────
Totals                         €105,200    €102,500

Additional Information for Adjustments:

  1. Prepaid Insurance: €2,400 paid for 12 months on January 1, 2024
  2. Prepaid Rent: €3,600 paid for 6 months on September 1, 2024
  3. Equipment: Cost €40,000, 5-year useful life, straight-line depreciation
  4. Unearned Revenue: €6,000 received for 3 months of services on October 1, 2024
  5. Accrued Salaries: Employees worked last week of November (€2,500) but won't be paid until December 5
  6. Accrued Interest: Bank loan €20,000 at 6% annual interest
  7. Supplies Used: €800 of supplies were used during November (currently in inventory)
  8. VAT Adjustment: Additional €500 VAT Payable from November sales not yet recorded
  9. Social Charges: Employer social charges for November total €2,000, to be paid in December

Required:

  1. Prepare all necessary adjusting entries with PCN account numbers and descriptions.

  2. Post adjusting entries to T-accounts (show before and after balances).

  3. Prepare an adjusted trial balance.

  4. Prepare:
    a) Income Statement for the month ended November 30, 2024
    b) Statement of Owner's Equity for the month ended November 30, 2024
    c) Balance Sheet as of November 30, 2024

  5. Verify that:
    a) The adjusted trial balance balances
    b) The accounting equation balances (Assets = Liabilities + Equity)
    c) Net income/loss flows correctly to Statement of Owner's Equity
    d) Ending equity flows correctly to Balance Sheet

  6. Explain how these adjustments ensure compliance with Luxembourg accounting requirements (PCN, accrual basis, etc.).

Cases​

Case 4-1: The Forgotton Adjustments

Marie's restaurant has been operating for six months. She's been recording all transactions but hasn't been making adjusting entries. Her accountant, Monsieur Schneider, is preparing the financial statements and discovers several items that need adjustment:

  • Insurance was paid in January for the whole year, but no monthly adjustments were made
  • Equipment depreciation was never recorded
  • Some services were provided in November but not yet billed
  • Salaries for the last week of November haven't been accrued
  • VAT calculations may be incorrect

Questions for Analysis:

  1. What impact do these missing adjustments have on the financial statements?

  2. How would the Income Statement be affected if these adjustments aren't made?

  3. How would the Balance Sheet be affected?

  4. What are the compliance implications of not making these adjustments in Luxembourg?

  5. How should Marie set up a system to ensure adjustments are made each month?

  6. What are the tax implications of incorrect financial statements due to missing adjustments?

Case 4-2: VAT and Social Charges Complexity

A Luxembourg SME is struggling with VAT and social charges adjustments. The business:

  • Makes sales with different VAT rates (3%, 8%, 17%)
  • Has employees with varying social charge rates
  • Receives services from EU and non-EU suppliers
  • Has complex VAT recovery situations

Questions for Analysis:

  1. How should the business track VAT for different rates and ensure proper accruals?

  2. What adjustments are needed for social charges, and when should they be made?

  3. How do EU vs. non-EU transactions affect VAT adjustments?

  4. What PCN accounts are involved in VAT and social charge adjustments?

  5. What are the compliance risks if these adjustments are incorrect?

  6. What systems or processes could help ensure accurate VAT and social charge adjustments?

Solutions are published in supplementary/instructor/solutions/chapter_04_solutions.md.