How does the accrual basis create accrued and prepaid items at balance day, and how are revenues and expenses adjusted to the correct period?
Record balance day adjustments for accrued expenses, prepaid expenses, accrued revenue and revenue received in advance, and explain how each adjustment affects profit and the balance sheet
WACE Year 12 Accounting and Finance Unit 3 on accruals and prepayments: recording accrued expenses, prepaid expenses, accrued revenue and revenue received in advance under the accrual basis, and explaining the effect of each on profit and the balance sheet.
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What this dot point is asking
SCSA wants you to record all four adjustments, classify the resulting balance correctly, and explain the effect on profit and the balance sheet.
The accrual basis
The four adjustments
The two expense adjustments fix the Income Statement expense and create either a liability (accrued) or an asset (prepaid). The two revenue adjustments fix revenue and create either an asset (accrued) or a liability (received in advance).
Working from the cash record
A reliable exam approach is to start from what the cash book shows and ask whether that figure matches the period's actual revenue or expense. If cash paid for an expense is more than the amount used up, the excess is a prepaid asset; if less, the shortfall is an accrued liability. The same logic applies to revenue: cash received that exceeds revenue earned is received in advance (a liability), while revenue earned beyond cash received is accrued revenue (an asset). Phrasing the adjustment as "what is the correct expense or revenue for this period, and how does it differ from the cash figure" prevents most errors.
Reversing entries in the new period
Some accrual and prepayment balances are reversed at the start of the next period so that the routine cash entry can be recorded normally without double counting. For example, after accruing wages of at year end, the business may reverse the accrual on day one of the new year; when the wages are paid, the full payment is debited to Wages Expense and the reversal has already removed the prior-period portion. Reversing entries are a convenience for bookkeeping; the key exam skill is the balance day adjustment itself and its effect on profit and the Balance Sheet.
Why the adjustments matter
Without balance day adjustments, profit would simply equal cash received less cash paid, which is the cash basis. That would let a business inflate profit by delaying payments or pulling forward receipts. The accrual adjustments enforce the matching principle and the revenue recognition criterion from the conceptual framework, so the Income Statement reports the period's genuine performance and the Balance Sheet reports the real assets and obligations that exist at year end.
Effect on the statements
Each adjustment changes profit and changes the balance sheet by the same logic. Recognising an accrued expense raises expenses, so it lowers profit, and it adds a liability. Recognising accrued revenue raises revenue, so it raises profit, and it adds an asset. Prepayments and revenue in advance work the same way in reverse. The double entry guarantees the balance sheet still balances.
Exam-style practice questions
Practice questions written in the style of SCSA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
WACE 20227 marksOn 1 April, Hale Services paid 2 400 in wages for the final week of the year. The financial year ends 30 June. Record both balance day adjustments and explain the effect of each on profit and the Balance Sheet.Show worked answer →
A 7 mark response needs both adjustments calculated, the journal entries, and the dual effect.
Prepaid rent. Three months (April to June) have been used: . Adjustment: debit Rent Expense , credit Prepaid Rent . Effect: expenses rise so profit falls ; the remaining stays as a current asset (nine months still prepaid).
Accrued wages. Adjustment: debit Wages Expense , credit Accrued Wages (liability) . Effect: expenses rise so profit falls a further ; a current liability is created.
Markers reward the time-apportioned prepaid figure, both correct journal entries, and a clear statement of the profit and Balance Sheet effect of each.
WACE 20245 marksA gym receives $6 000 on 1 May for annual memberships and records it as Revenue Received in Advance. By 30 June, two months of membership have been provided. Record the adjustment and explain why the unearned portion is a liability.Show worked answer →
A 5 mark response needs the earned portion, the entry, and the liability reasoning.
Earned portion. Two of twelve months provided: earned. Adjustment: debit Revenue Received in Advance , credit Membership Revenue .
Effect. Revenue earned is , raising profit by . The remaining stays as a current liability because the gym still owes ten months of service; if it failed to deliver, it would have to refund members. Markers reward the apportioned earned figure, the correct entry, and the obligation explanation for the liability.