Horse Country Living publishes a monthly magazine for which a 12-month subscription costs $30. All subscriptions require payment of the full $30 in advance. On August 1, 2008, the balance in the Subscriptions Received in Advance account was $40,500. During the month of August, the company sold 900 yearly subscriptions. After the adjusting entry at the end of August, the balance in the Subscriptions Received in Advance account is $60,000.
Required
1. Prepare the journal entry to record the sale of the 900 yearly subscriptions during the month of August.
2. Prepare the adjusting journal entry on August 31.
3. Assume that the accountant made the correct entry during August to record the sale of the 900 subscriptions but forgot to make the adjusting entry on August 31. Would the net income for August be overstated or understated? Explain your answer.
1. To record the sale of the 900 yearly subscriptions during the month of August, you would debit Cash for the total amount received ($30 x 900 = $27,000) and credit Subscriptions Received in Advance for the same amount.
Journal Entry:
Debit: Cash $27,000
Credit: Subscriptions Received in Advance $27,000
2. To make the adjusting entry on August 31, you would need to recognize the portion of the subscriptions that have been earned during the month. Since it is a monthly magazine, only 1/12th of each subscription has been earned.
To calculate the amount earned, divide the total Subscriptions Received in Advance at the beginning of the month ($40,500) by 12 to get the monthly amount ($40,500 / 12 = $3,375). Then multiply that by the number of subscriptions sold in August (900).
Adjusting Journal Entry:
Debit: Subscriptions Received in Advance $3,375
Credit: Subscription Revenue $3,375
3. If the accountant forgot to make the adjusting entry on August 31, the net income for August would be overstated. This is because the revenue from the subscriptions that were earned during August ($3,375) would not be recognized, resulting in higher net income.
Without the adjusting entry, the entire amount received in advance ($27,000) would be recorded as revenue, even though a portion of it represents future services to be provided. As a result, the net income would be higher than it should be, overstating the company's profitability for the month of August.