Apply the accrual basis to record balance day adjustments for prepaid and accrued expenses, accrued and unearned revenue, and depreciation, so that the income statement and balance sheet are accurate

What this dot point is asking

QCAA wants you to apply the accrual basis at balance day, the last day of the reporting period. Under accrual accounting, revenue is recognised when earned and expenses when incurred, regardless of when cash moves. Because cash and the actual earning or incurring rarely line up exactly, the records need adjusting before the financial statements are drawn up. You must record prepaid expenses, accrued expenses, accrued revenue and unearned revenue, each of which creates or changes a current asset or current liability and corrects the profit figure.

The accrual basis and why adjustments exist

The accrual basis recognises revenue when it is earned and expenses when they are incurred, matching them to the period they belong to rather than to the period cash changes hands. During the year transactions are often recorded on a cash basis for convenience, so at balance day the records contain amounts that relate to other periods. Balance day adjustments correct this, applying the matching concept (expenses matched to the revenue and the period they help generate) and ensuring the income statement shows true profit and the balance sheet shows true assets and liabilities.

The four adjustment types

Prepaid expense (asset)

The business has paid for something it has not yet fully used, such as insurance paid 12 months in advance. The unused portion is an asset. Adjustment: debit Prepaid Expense (current asset), credit the expense. This reduces the expense to only the amount used in the period.

Accrued expense (liability)

The business has used something it has not yet paid for, such as wages owing at year end. Adjustment: debit the expense, credit Accrued Expense (current liability). This increases the expense to include what was incurred but unpaid.

Accrued revenue (asset)

The business has earned revenue it has not yet received, such as interest earned but not yet credited. Adjustment: debit Accrued Revenue (current asset), credit the revenue. This increases revenue to include what was earned but uncollected.

Unearned revenue (liability)

The business has received cash for something it has not yet delivered, such as a deposit for goods to be supplied next period. The unearned portion is a liability. Adjustment: debit the revenue, credit Unearned Revenue (current liability). This reduces revenue to only the amount earned.

Depreciation is also a balance day adjustment: it allocates part of a non-current asset's cost to the period as an expense and accumulates against the asset. It is treated in full on the non-current assets page; the key point here is that it is recorded at balance day along with the other adjustments.

The effect on the statements

Every adjustment touches one income statement account and one balance sheet account. Expense adjustments change profit and create an asset (prepaid) or liability (accrued). Revenue adjustments change profit and create an asset (accrued) or liability (unearned). Because they alter profit, getting them wrong misstates both the income statement and the balance sheet, which is why they are made before the statements are prepared and why the closing capital figure depends on them.