Question

Baltimore Company paid $3,600 cash for the right to use office space during the coming year. Which of the following shows how this event would affect Baltimore's ledger accounts?

A. Assets = Liabilities + Stockholders' Equity
Cash + Prepaid Rent =
(3,600) 3,600

B. Assets = Liabilities + Stockholders' Equity
Prepaid Rent = Accounts Payable
3,600 3,600

C. Assets = Liabilities + Stockholders' Equity
Prepaid Rent = Retained Earnings
3,600 3,600

D. Assets = Liabilities + Stockholders' Equity
Prepaid Rent = Retained Earnings
(3,600) (3,600)

Answer 1

A. Assets = Liabilities + Stockholders' Equity

Cash + Prepaid Rent =

(3,600) 3,600

So, the correct option is a.

Explanation:

This transaction involves Baltimore Company paying $3,600 in cash for the right to use office space. The accounting equation, Assets = Liabilities + Stockholders' Equity, reflects the company's financial position. In this case, an increase in Prepaid Rent (an asset) is accompanied by a decrease in Cash. Therefore, option A correctly represents the dual impact on the accounting equation. The debit entry to Prepaid Rent increases the asset, while the credit entry to Cash decreases another asset.

Now, let's break down the explanation into three paragraphs:

1. Transaction Overview:

Baltimore Company's payment for the right to use office space represents a prepaid expense, as the benefit (office space) will be realized over time. This transaction impacts two accounts: Cash (a current asset) is reduced by $3,600, and Prepaid Rent (an asset representing future benefits) is increased by the same amount.

2. Impact on the Accounting Equation:

The accounting equation, Assets = Liabilities + Stockholders' Equity, must always balance. In this case, assets are affected. The increase in Prepaid Rent is reflected on the left side of the equation, and the decrease in Cash is shown with parentheses on the same side. This maintains the balance of the accounting equation.

3. Choice of Option A:

Option A correctly captures the essence of this transaction. It concisely presents the impact on Cash and Prepaid Rent in a clear format. The use of parentheses indicates a decrease in Cash, aligning with standard accounting conventions. Options B, C, and D either incorrectly represent the accounts affected or fail to balance the accounting equation.

This comprehensive explanation outlines the nature of the transaction, its impact on accounts, and why option A is the accurate representation of the event in terms of accounting principles.

Answer 2

The correct representation of how the event affects Baltimore's ledger accounts is option D: Assets = Liabilities + Stockholders' Equity, with Prepaid Rent decreasing and impacting Retained Earnings negatively by $3,600.

Step-by-step explanation:

When Baltimore Company pays $3,600 for the right to use office space for the upcoming year, it impacts the ledger accounts in a specific manner. This transaction involves the reduction of an asset (Cash) as it's used to acquire a prepaid expense (Prepaid Rent). Prepaid Rent, an asset account, increases by $3,600, while Cash decreases by the same amount.

However, this transaction doesn't directly influence liabilities or stockholders' equity. The impact reflects in the equity section's Retained Earnings, reducing it by $3,600 due to the decrease in assets. Retained Earnings, as a component of stockholders' equity, decreases when an asset is utilized or reduced.

Option D accurately captures this event: Prepaid Rent increases as it represents a future benefit acquired, and Retained Earnings decreases due to the reduction in the asset value. The equation Assets = Liabilities + Stockholders' Equity must always remain balanced, and in this case, the reduction in Cash leads to a corresponding decrease in the asset Prepaid Rent, reflected in the equity account Retained Earnings.