Final answer:
The correct adjustment for Accounting Associates on December 31, Year 1, is to decrease Unearned Revenue by $500 and to increase Retained Earnings by $500, reflecting the earned revenue for five months of service provided.
Step-by-step explanation:
The student's question relates to how to account for prepaid revenue and how it affects the accounting equation within a business's ledger accounts. On August 1, Year 1, Accounting Associates (AA) received $1,200 for services to be provided over the next year. By December 31, Year 1, AA would have provided five months of service, equating to a value of $1,200/12 months * 5 months = $500. This amount should be reported as earned revenue.
Hence, the necessary adjustment would reduce the Unearned Revenue (a liability) by $500, and increase Retained Earnings (an element of Stockholders' Equity) by $500 to reflect the earned portion of the service. This is shown in the adjusted trial balance by:
- Decreasing Unearned Revenue (a liability) by $500
- Increasing Retained Earnings by $500
The correct ledger adjustments based on this scenario would be as follows:
Assets = Liabilities + Stockholders' Equity
= Unearned Revenue + Retained Earnings (500) 500