Luton Inc Solution Strictly Confidential

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Luton Inc Solution
Luton Inc. has a year end of December 31 2009.

For each of the following transactions, show which figure would be shown in:
Income statement
Cash
Prepayment
Accruals

Transactions:

1.   Purchased a one year software license for $6,000 on November 1 2009.

The payment was made in full on November 1, 2009.

2.   Paid $1,300 of interest expense on January 3, 2010.

Interest is to be paid monthly and is for loans outstanding as of the month of December, 2009.

3.   Sold a training contract to be delivered on January 31, 2010.

The course fee is $2,000 which will be payable 30 days after the course.
There is also a development fee of $5,000 payable at the same time as the course fee.
The development will be carried out in December 2009 and January 2010 and will equal work being done in bot

Solution

Transaction 1 Dr Cr
Software expense (Income statement) 1,000
Cash (Balance sheet) 6,000
Prepayment (Balance sheet) 5,000
Accruals (Balance sheet)
6,000 6,000

Transaction 2 Dr Cr
Interest expense (Income statement) 1,300
Cash (Balance sheet)
Prepayment
Accrued expense (Balance sheet) 1,300
1,300 1,300

Transaction 3 Dr Cr
Revenue (Income statement) 2,500
Cash (Balance sheet)
Prepayment (Balance sheet)
Accrued income (Balance sheet) 2,500
2,500 2,500
work being done in both months.

The full payment of $6,000 was made on Nov 1 so there is a credit in cash on the balance sheet,
but the actual expenses will be incurred every month. The monthly expense will be $6,000/12 =
$500. On Dec 31, a total of $1,000 ($500 x 2 = $1,000) software expenses is shown on the
income statement because two months has passed by that time. This will debit the software
expense account by $1,000. The rest of $5,000 is recorded as a debit in prepaid expenses
(current asset) on the balance sheet.

The $1,300 was for interest due on Dec 31, 2009. However, Luton did not make the payment
until January 3, 2010. Thus, an expense was incurred and accrued since no payment was made
yet. On Dec 31, $1,300 is debited as the interest expense. Then, to close the books, accrued
expense must be credited for $1,300 as well to that debits and credits balance. This entry will
be reversed in the following year and expenses will be re-recognized with the actual payment.

The course fee of $2,000 is only payable after the completion of course so no revenue is
incurred on Dec 31. The development fee of $5,000 is incurred monthly ($5,000/2 = $2,500) in
Dec and Jan. On Dec 31, there is a $2,500 revenue for the month of Dec shown on the income
statement. There is also a $2,500 accrued income in the current asset section of the balance
sheet because it will be received at the same time as the course fee.