[Biff-1955-Tannen]

I’m having an absolute hell of a time figuring out what is even happening in this situation. Actual question and solution start about halfway through post. In my head this is what was happening:

on 1/1 we prepay royalties so the entry would be (dr) Prepaid royalty 65,000 (cr) cash 65,000

on 10/31 we remit the royalty payments, so the entry would be

(dr) Royalty expense ???? (cr) prepaid royalty 65,000 (cr) cash ??? <— how am I supposed to know what the actual expense was this year?

on 10/31 we also account for next years prepaid royalties, so the entry would be (dr) prepaid royalty ??? (cr) cash ??? <— how am I supposed to know what we estimate for royalties for next year?

On 12/31 it says that we adjust the prepaid royalty, (why we’re adjusting the year end royalty expense is beyond me) Honestly I don’t even know what the entry would be for this since it says that it is a year end CREDIT adjustment, but in the explanation it’s adding to the prepaid royalties.

Obviously I’m doing something wrong here, and I have apparently absolutely no idea whats happening. Does anybody else understand what happening and feel like explaining this?

Ott Company acquired rights to a patent from Grey under a licensing agreement that required an advance royalty payment when the agreement was signed. Ott remits royalties earned and due, under the agree­ment, on October 31 each year. Additionally, on the same date, Ott pays, in advance, estimated royalties for the next year. Ott adjusts prepaid royalties at year-end. Information for the current year ended December 31 is as follows:

Date Amount

---

---

01/01 Prepaid royalties $ 65,000

10/31 Royalty payment (charged to royalty expense) 110,000

12/31 Year-end credit adjustment to royalty expense 25,000

In its December 31 balance sheet, Ott should report prepaid royalties of:

Here one needs to convert from the cash method to the accrual method as to the deferred amount of royalty expenses. The royalty payment was charged to (added to) royalty expense, but there was also a year-end credit adjustment downwards to royalty expense. The only reasonable debit to the year-end credit to royalty expense would be to debit (add to) prepaid royalties, as this could only be deferred (not properly accrued this year) royalty expenses.

So far, prepaid royalties have had a debit balance of $65,000, and if one adds an additional debit to prepaid royalties of $25,000, there will be an ending balance of prepaid royalties of $90,000.

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

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[536FrenchmenStreet]

I hate when they word questions like this. My guess is you're supposed to assume that the annual royalty amount is $65K because in the given they state that Ott began the year with $65K in prepaid royalties.

BEC: Fall 2016
AUD: Spring 2016
REG: Summer 2016
FAR: RETAKE

[Biff-1955-Tannen]

That's one of the things that I thought of as well, but then I remembered that they say they base the prepayment on an estimate of next year. So that sounds like it isn't a set amount each year which would mean it's probably not going to be 65k again, ya know?

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[536FrenchmenStreet]

What, you want these clowns to make sense now?!!!

BEC: Fall 2016
AUD: Spring 2016
REG: Summer 2016
FAR: RETAKE

[monikernc]

i get a balance of prepaid royalty of $25,000 at 12/31.

do you know what the answer is?

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[Biff-1955-Tannen]

Sorry forgot to put the answer, the answer is 90,000

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[monikernc]

it is a tad hard to follow but…try this…

balance of prepaid royalty at 1/1/Y2 is $65,000, no entry just a balance in the prepaid account, based on the 12/31/Y1 accrual.

on 10/31/Y2 dr royalty exp 110,000
——————cr cash 110,000

12/31/Y2 dr prepaid royalty 25,000
————–cr royalty exp 25,000

i originally posted that the 10/31 JE included a credit to prepaid royalty for 65,000 and cash 45,000. but if the answer is 90,000 in the prepaid royalty account on 12/31, then the entries above should do it

FAR 7/25/15 76!
AUD 10/30/15 93
BEC 2/27/16 82
REG 5/23/16 88!
Ninja Book and MCQ and the forum - all the way!!!
and a little thing i like to call, time and effort!
if you want things to change, you have to do something different

[Biff-1955-Tannen]

I guess I just don't understand what the point of having a prepaid asset is if you never expense it

AUD 93 Jan 16
BEC 83 Feb 16
FAR 83 Apr 16
REG 84 May 16

99% Ninja MCQ only

[monikernc]

i totally agree. i would have thought prepaid royalty would have been 25,000 at 12/31.

FAR 7/25/15 76!
AUD 10/30/15 93
BEC 2/27/16 82
REG 5/23/16 88!
Ninja Book and MCQ and the forum - all the way!!!
and a little thing i like to call, time and effort!
if you want things to change, you have to do something different

[monikernc]

So Biff… the year starts with 65,000 in prepd. On 10/31 You pay another 110,000, so prepaid goes to $175,000. Royalty exp has a debit balance of $110,000. At 12/31 you determine that Royalty Exp for the year is only $85,000 so you credit it for 25,000. Prepd is credited 85,000 when royalty expense is closed out at year end and the prepaid balanced drops to 90,000. But i can't get JEs to work.

FAR 7/25/15 76!
AUD 10/30/15 93
BEC 2/27/16 82
REG 5/23/16 88!
Ninja Book and MCQ and the forum - all the way!!!
and a little thing i like to call, time and effort!
if you want things to change, you have to do something different

[FIFOisbetterthanLIFO]

I think the question is saying that we need an appropriate adjusting entry for royalty expense.The balance in prepaid is 65k. It says 110k is expensed when the payment is made (110k to royalty expense and 110k to cash)…obviously this is incorrect based on the information the question gave us.

When they get to year-end they figure out that they expensed 25k too much so it needs to be credited from the expense account and debited to the prepaid account. 65k beginning balance plus 25k debit (since we credited expense you must debit prepaid to add it back) gives you an ending balance of 90k.

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REG - Passed! (81)
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