Prepare balance day adjustments for accruals, prepayments, depreciation and doubtful debts to produce accurate final reports

Balance day adjustments apply the accrual basis at year end: accrued and prepaid expenses, accrued and unearned revenue, depreciation and doubtful debts are recorded so that profit and position are stated correctly.

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What this dot point is asking
Why adjustments are needed
The five adjustment types
Depreciation and doubtful debts
Effect on both statements

What this dot point is asking

You need to identify when an adjustment is required, prepare the adjusting journal entry, and explain how it changes the income statement and the balance sheet.

Why adjustments are needed

The accrual basis says revenue is recognised when earned and expenses when incurred, regardless of cash timing. During the year transactions are recorded as cash moves, so at balance day some accounts are wrong. Adjustments correct them, applying the matching idea that expenses are reported in the same period as the revenue they help earn.

The five adjustment types

Depreciation and doubtful debts

Depreciation spreads the cost of a non-current asset over its useful life. The straight-line entry is Dr Depreciation expense, Cr Accumulated depreciation (a contra-asset that reduces the carrying amount on the balance sheet).

The allowance for doubtful debts applies prudence: some debtors will not pay, so an estimated expense is recognised now. The entry is Dr Bad and doubtful debts expense, Cr Allowance for doubtful debts (a contra-asset that reduces net debtors).

Adjusting at balance day

Four items at 30 June

**Wages of \ $2,000 are owing but unpaid.** Dr Wages expense \$ 2,000; Cr Accrued wages \ $2,000. Expenses rise \$ 2,000, a current liability appears.
**Insurance \ $3,600 was paid on 1 April for a full year.** Only three months ($ \ $900$ ) is used this year; nine months ( $\$ 2,700 $) is prepaid. Dr Prepaid insurance \$ 2,700; Cr Insurance expense \ $2,700. The expense falls to the used portion, an asset of \$ 2,700 appears.
**Depreciation on equipment is \ $5,000.** Dr Depreciation expense \$ 5,000; Cr Accumulated depreciation $5,000. Profit falls; carrying amount falls.
**Doubtful debts estimated at \ $1,200.** Dr Bad and doubtful debts expense \$ 1,200; Cr Allowance for doubtful debts $1,200. Net debtors fall to a more realistic figure.

Net effect on profit: expenses change by $+2{,}000 - 2{,}700 + 5{,}000 + 1{,}200 = +5{,}500$ , so profit falls $5,500 once the unused insurance is removed from expenses.

Effect on both statements

Every adjustment touches the income statement and the balance sheet. An accrued expense raises expenses (lower profit) and creates a liability. A prepaid expense lowers the current expense and creates an asset. This dual effect is why adjustments must be made before the reports are prepared, never after.

Exam-style practice questions

Practice questions written in the style of SACE Board exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

2022 SACE Stage 23 marksComplete the general journal entries to record the adjustments shown: adjustment for prepaid insurance, and adjustment for unearned service revenue. (Prepaid insurance of

3,600 was paid on 1 June and covers the 6 months to 30 November 2022; services revenue includes

1,340 for work that will not be performed until 10 July 2022.)

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Work out the unused portion of each item, then record the adjustment.

Prepaid insurance. The $3,600 covers 6 months. At 30 June only 1 month (1-30 June) is used, so the expense is$ 3,600 / 6 = $600 and the unused$ 3,000 stays an asset. The payment was first recorded as prepaid insurance (an asset), so the adjustment transfers the used part to expense: Dr Insurance expense $600; Cr Prepaid insurance$ 600. This recognises only the incurred portion (matching) and reduces the asset to $3,000.
Unearned service revenue. The $1,340 has been received but the work is not performed until 10 July, so it is not yet earned. Revenue is currently overstated, so: Dr Services revenue$ 1,340; Cr Unearned service revenue (a liability) $1,340. This defers the income to the period in which it is earned, applying the accrual basis.

Markers want the correct accounts, the correct dollar amounts and the right debit and credit direction for each entry.

2023 SACE Stage 22 marksDiscuss the principle of faithful representation and how it applies to balance day adjustments.

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Faithful representation means financial information should depict economic reality completely, neutrally and free from material error, so the reports are reliable for decision making.

Balance day adjustments are how this principle is applied at year end. Without them the ledger only reflects cash that has moved, which would not faithfully represent the business. For example:

Accruing wages owing recognises an expense and a liability that genuinely exist at balance day.
Recording depreciation and the allowance for doubtful debts states assets at amounts the business can realistically expect to recover.
Adjusting prepayments and unearned revenue reports only the expense incurred and the revenue earned in the period.

By making these adjustments, profit and the balance sheet faithfully represent performance and position rather than overstating or understating them. Markers reward a clear definition plus at least one linked adjustment example.