Fragmental Co. leased a portion of its store to another company for eight months beginning on October 1, at a monthly rate of $800. Fragmental collected the entire $6,400 cash on October 1 and recorded it as unearned revenue. Assuming adjusting entries are only made at year-end, the adjusting entry made by Fragmental Co. on December 31 would be:
A) A debit to Rent Revenue and a credit to Cash for $2,400.
B) A debit to Rent Revenue and a credit to Unearned Rent for $2,400.
C) A debit to Unearned Rent and a credit to Rent Revenue for $4,000.
D) A debit to Unearned Rent and a credit to Rent Revenue for $2,400.
E) A debit to Cash and a credit to Rent Revenue for $6,400.

Question

Quizplus · Accepted Answer

Since the company collected the entire amount of $6,400 at the beginning of the lease, it recorded it as unearned rent. However, the company must recognize the earned revenue for the portion of the lease that has already expired at the end of each accounting period.

As of December 31, two months of the eight-month lease have already expired (October and November). Therefore, the adjusting entry required is to debit the unearned rent account for the amount of rent that has been earned so far (which is $800 x 2 = $1,600), and credit the rent revenue account for the same amount.

Thus, the adjusting entry on December 31 would be a debit to Unearned Rent and a credit to Rent Revenue for $2,400 ($800 x 3 months). The correct answer is D.