Calculating Net Income: Unadjusted vs. Adjusted Trial Balance – Fortune Inc.

QUESTION

Fortune Inc. prepared the following unadjusted trial balance at the end of its third year of operations ending December 31. Account Titles Debit Credit Cash $12,000 Accounts Receivables 6,000 Prepaid Rent 2,400 Equipment 21,000 Accumulated Depreciation $1,000 Accounts Payable 1,000 Income tax payable 0 Common stock 24,800 Retained earnings 2,100 Sales revenue 50,000 Salaries and Wages 25,000 Utilities 12,500 Rent 0 Depreciation expense 0 Income tax expense 0 Total $78,900 $78,900 Other data not yet recorded at December 31: a. Rent expired during the year, $1,200 b. Depreciation expense for the year, $1,000 c. Utilities used and upaid, $9,000 d. Income tax expense, $390 Compute the amount of Net Income using: a. the preliminary (unadjusted) numbers and b. the final (adjusted) numbers.

ANSWER

Calculating Net Income: Unadjusted vs. Adjusted Trial Balance – Fortune Inc.

Introduction

Fortune Inc., a company completing its third year of operations, has prepared an unadjusted trial balance as of December 31. While the trial balance provides a snapshot of the company’s financial position, it requires adjustments to accurately calculate net income. In this essay, we will examine the preliminary (unadjusted) numbers and the final (adjusted) numbers to determine the amount of net income.

Unadjusted Trial Balance Analysis

Upon reviewing Fortune Inc.’s unadjusted trial balance, we observe several account titles along with their debit and credit balances. The cash account shows a balance of $12,000, indicating the amount of available cash at the end of the year. Accounts receivable amount to $6,000, representing outstanding payments from customers. Prepaid rent stands at $2,400, signifying the amount paid in advance for rent expense. Equipment is valued at $21,000, representing the company’s fixed assets.

Additionally, the trial balance includes accumulated depreciation of $1,000, reflecting the depreciation recorded on the equipment over its useful life. Accounts payable indicate a liability of $1,000, representing unpaid amounts to creditors. Notably, the income tax payable is listed as $0, suggesting that no income taxes have been accrued or paid yet. Common stock stands at $24,800, representing the capital contributed by shareholders. Retained earnings amount to $2,100, reflecting the cumulative profits or losses of the company. Sales revenue indicates total sales of $50,000, while expenses include salaries and wages of $25,000 and utilities of $12,500.

Adjustments for Accrued Expenses and Depreciation

To determine the net income accurately, we need to make certain adjustments to the unadjusted trial balance. The first adjustment relates to the rent expense. Rent in the amount of $1,200 has expired during the year but has not been recorded. This adjustment recognizes the portion of the rent expense that corresponds to the current reporting period.

The second adjustment accounts for depreciation expense. Although the unadjusted trial balance does not reflect depreciation, it is essential to allocate a portion of the equipment’s cost as an expense. With a depreciation expense of $1,000 for the year, we can accurately match the cost of equipment with the corresponding period’s revenue.

Further Adjustments for Accrued Liabilities

Fortune Inc. also has unpaid expenses that need to be recognized. The adjustment for utilities reveals that $9,000 worth of utilities have been used but remain unpaid as of December 31. By recognizing this expense, we align it with the period it corresponds to, allowing for a more accurate calculation of net income.

Lastly, an adjustment for income tax expense is required. The unadjusted trial balance does not include any income tax expense, but based on the company’s operations, an income tax expense of $390 needs to be recognized.

Calculating Net Income

With all the necessary adjustments made, we can now compute the net income using both the preliminary (unadjusted) numbers and the final (adjusted) numbers.

Preliminary (Unadjusted) Net Income:
Preliminary net income can be determined by subtracting total expenses ($25,000 + $12,500) from total revenue ($50,000). Thus, the preliminary net income is $12,500.

Final (Adjusted) Net Income:
To calculate the final net income, we deduct the adjusted expenses from the adjusted revenue. Adjusted revenue remains at $50,000. Adjusted expenses consist of salaries and wages ($25,000), utilities ($12,500), rent expense ($1,200), depreciation expense ($1,000), and income tax expense ($390). Subtracting these adjusted expenses from adjusted revenue, we find that the final net income is $9,910.

Conclusion

In conclusion, by considering the adjustments made to Fortune Inc.’s unadjusted trial balance, we were able to compute both the preliminary and final net income. The preliminary net income, calculated without the necessary adjustments, amounted to $12,500. However, after incorporating adjustments for accrued expenses, depreciation, and accrued liabilities, the final net income was determined to be $9,910. It is crucial for businesses to make these adjustments to accurately represent their financial performance and ensure the integrity of their financial statements.