Accrued and Prepaid Items WACE Accounting and Finance Unit 3
“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”
The accrual basis records revenue when earned and expenses when incurred, not when cash moves. At balance day this creates four adjustments. Accrued expenses are incurred but unpaid (a liability). Prepaid expenses are paid in advance (an asset). Accrued revenue is earned but not yet received (an asset). Revenue received in advance is collected but not yet earned (a liability). Each adjustment moves an amount into the correct period and creates a matching asset or liability.
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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
Under the accrual basis, the effects of transactions are recognised when they occur, not when cash is received or paid. Revenue is recognised when it is earned and expenses when they are incurred. Balance day adjustments bring the accounts onto this basis so that profit reflects the period's real performance.
The four adjustments
An accrued expense (for example wages owed) is incurred but unpaid: increase an expense and create a current liability. A prepaid expense (for example insurance paid ahead) is paid but not yet used: reduce the expense and create a current asset. Accrued revenue (for example interest earned but not received) increases revenue and creates a current asset. Revenue received in advance (for example a deposit) reduces revenue earned and creates a current liability until the service is delivered.
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.
For an annual amount paid in advance, the portion used , and the portion remaining (the asset) . The same fraction logic works for any time period.
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.
On 1 March, Marlo Ltd pays $12 000 for a 12-month insurance policy and records it as Prepaid Insurance. The financial year ends 30 June.
By 30 June, four months of cover (March to June) have been used, so the insurance expense incurred is:
The adjustment is debit Insurance Expense $4 000, credit Prepaid Insurance $4 000. The Income Statement now shows $4 000 expense, and the Balance Sheet shows the remaining $8 000 as a current asset (eight months still prepaid).
At the same date, Marlo has earned but not received $1 500 of interest on a term deposit. The adjustment is debit Accrued Interest Revenue (asset) $1 500, credit Interest Revenue $1 500. Profit rises by $1 500 and a $1 500 current asset is created. Together the two adjustments raise expenses by $4 000 and revenue by $1 500.
Students often record the Income Statement side of the adjustment but forget that the other side is a real asset or liability on the Balance Sheet. A prepaid expense leaves a current asset; an accrued expense leaves a current liability. Omitting the balance sheet item leaves the accounts out of balance and misstates the entity's resources and obligations at year end.
Exam-style questions
Questions in the style of SCSA exam questions on this dot point, each with a worked answer. They are written by ExamExplained unless tagged "Past paper"; the year shows the paper a question is modelled on.
WACE 2022-style7 marksOn 1 April, Hale Services paid $9 600 for a 12-month rent agreement and recorded it as Prepaid Rent. It also owes employees $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 2024-style5 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.