Question

Fowler Company’s December 31, Year 1 balance sheet showed $1,700 cash, $1,000 common stock, and $700 retained earnings. The company experienced the following event during Year 2.

On October 1, collected $1,200 in advance for an agreement to provide office space for one year beginning immediately.
Based on this information alone,
a. the Year 2 income statement would show
$300 of unearned rent revenue.
b. the Year 3 income statement would show $900 of rent revenue.
c. the Year 2 balance sheet would show $300 of unearned rent revenue.
d. the Year 3 balance sheet would show $900 of rent revenue.

Answer 1

The Year 2 income statement and balance sheet will show $300 as earned and $900 as unearned rent revenue, respectively. The Year 3 income statement will then show $900 of rent revenue earned over that year. By the end of Year 3, all rent revenue from this transaction will be recognized with no unearned balance.

Step-by-step explanation:

When Fowler Company collected $1,200 in advance for rent, it created an unearned revenue liability because the service (office space) will be provided over the next year. At the end of Year 2, 3 months of office space has been provided (October 1 to December 31), so the company can recognize $300 (3/12 of $1,200) as earned revenue.

Thus, the Year 2 income statement would show $300 of rent revenue being earned, and the Year 2 balance sheet would report $900 ($1,200 - $300) as unearned rent revenue because this amount has been collected but not yet earned.

Subsequently, in Year 3, the remaining 9 months (January 1 to September 30) of the office space will be provided, and the company can recognize the remaining $900 as rent revenue. As such, the Year 3 income statement would show $900 of rent revenue, and by the end of Year 3, there will be no unearned rent revenue remaining on the balance sheet related to this transaction, as all the revenue has been recognized.