Balance Day Adjustments

Introduction to Balance Day Adjustments (BDAs)

• Balance day adjustments are made at the end of an accounting period to ensure that financial reports accurately reflect the business’s financial performance and position.
• They are necessary because some transactions may not be fully recorded or may have occurred over multiple accounting periods.
• BDAs apply the accrual basis of accounting, which recognizes revenue when earned and expenses when incurred, regardless of when cash changes hands.
• Period assumption: The life of the business is divided into discrete periods.
• Going concern assumption: The business will continue to operate in the foreseeable future.
• Relevance (Qualitative Characteristic): Information must be capable of influencing decisions of users.

KEY TAKEAWAY: Balance day adjustments are crucial for accurate financial reporting under the accrual basis of accounting.

Prepaid Expenses (Asset Approach)

• Definition: Expenses paid in advance for goods or services to be used in a future accounting period.
• Asset Approach: The initial payment is recorded as an asset (Prepaid Expense) because the business has a future economic benefit.
• GST: GST is recorded at the time of payment.
• Balance Day Adjustment: At the end of the period, an adjustment is made to recognize the portion of the prepaid expense that has been consumed or expired.

Recording Prepaid Expenses

1. Initial Payment:
   • Debit: Prepaid Expense (Asset)
   • Debit: GST Clearing (if applicable)
   • Credit: Bank
2. Balance Day Adjustment:
   • Debit: Expense (e.g., Rent Expense, Insurance Expense)
   • Credit: Prepaid Expense (Asset)

Example

A business pays \$12,000 for a one-year insurance policy on 1 July 2024. The accounting period ends on 30 June 2025. GST is 10%.

1. Initial Payment (1 July 2024):
   • Debit: Prepaid Insurance \$12,000
   • Debit: GST Clearing \$1,200
   • Credit: Bank \$13,200
2. Balance Day Adjustment (30 June 2025):
   • Debit: Insurance Expense \$12,000
   • Credit: Prepaid Insurance \$12,000

Reporting

• Balance Sheet: The unexpired portion of the prepaid expense is reported as a current asset.
• Income Statement: The expired portion is reported as an expense.

REMEMBER: Asset approach treats the initial payment as an asset, which is then expensed over time.

Accrued Expenses

• Definition: Expenses that have been incurred but not yet paid for at the end of the accounting period.
• GST: GST is recorded at the time of payment.
• Balance Day Adjustment: An adjustment is made to recognize the expense and create a liability (Accrued Expense).

Recording Accrued Expenses

1. Balance Day Adjustment:
   • Debit: Expense (e.g., Wages Expense, Interest Expense)
   • Credit: Accrued Expense (Liability)
2. Payment in Subsequent Period:
   • Debit: Accrued Expense (Liability)
   • Debit: GST Clearing (if applicable)
   • Credit: Bank

Example

A business owes \$3,000 in wages to employees at the end of the accounting period (30 June 2024). Wages are paid on 5 July 2024. GST is 0% as it is a wage.

1. Balance Day Adjustment (30 June 2024):
   • Debit: Wages Expense \$3,000
   • Credit: Accrued Wages \$3,000
2. Payment (5 July 2024):
   • Debit: Accrued Wages \$3,000
   • Credit: Bank \$3,000

Reporting

• Balance Sheet: Accrued expenses are reported as a current liability.
• Income Statement: The expense is reported in the period it was incurred.

EXAM TIP: Be careful with GST on accrued expenses. Wages do not have GST.

Unearned Revenue (Liability Approach)

• Definition: Cash received in advance for goods or services to be provided in a future accounting period.
• Liability Approach: The initial receipt is recorded as a liability (Unearned Revenue) because the business has an obligation to provide goods or services in the future.
• GST: No GST is recorded at the time of the deposit. GST is only recognised when the revenue is earned.
• Balance Day Adjustment: At the end of the period, an adjustment is made to recognize the portion of the revenue that has been earned.

Recording Unearned Revenue

1. Initial Receipt:
   • Debit: Bank
   • Credit: Unearned Revenue (Liability)
2. Balance Day Adjustment:
   • Debit: Unearned Revenue (Liability)
   • Credit: Revenue (e.g., Service Revenue, Sales Revenue)
   • Credit: GST Clearing (if applicable)

Example

A business receives \$5,500 in advance on 1 May 2024 for services to be performed over the next 5 months. The accounting period ends on 30 June 2024. The \$5,500 includes GST.

1. Initial Receipt (1 May 2024):
   • Debit: Bank \$5,500
   • Credit: Unearned Revenue \$5,500

2. Balance Day Adjustment (30 June 2024):

   Calculate the amount of revenue earned:

   Revenue earned = \$5,500 / 5 months * 2 months = \$2,200

   Calculate the GST component:

   GST = \$2,200 / 11 = \$200

   Calculate the Net Revenue:

   Net Revenue = \$2,200 - \$200 = \$2,000

   Record the journal entry:

   • Debit: Unearned Revenue \$2,200
   • Credit: Service Revenue \$2,000
   • Credit: GST Clearing \$200

Reporting

• Balance Sheet: The unearned portion of the revenue is reported as a current liability.
• Income Statement: The earned portion is reported as revenue.

STUDY HINT: Practice journal entries for unearned revenue and ensure you understand the GST implications.

Accrued Revenue

• Definition: Revenue that has been earned but not yet received in cash at the end of the accounting period.
• GST: GST is recorded at the time of receipt.
• Balance Day Adjustment: An adjustment is made to recognize the revenue and create an asset (Accrued Revenue).

Recording Accrued Revenue

1. Balance Day Adjustment:
   • Debit: Accrued Revenue (Asset)
   • Credit: Revenue (e.g., Interest Revenue, Service Revenue)
2. Receipt in Subsequent Period:
   • Debit: Bank
   • Debit: GST Clearing (if applicable)
   • Credit: Accrued Revenue (Asset)

Example

A business has earned \$1,100 in interest revenue at the end of the accounting period (30 June 2024), but the cash will be received on 15 July 2024. The \$1,100 includes GST.

1. Balance Day Adjustment (30 June 2024):
   • Debit: Accrued Interest Revenue \$1,100
   • Credit: Interest Revenue \$1,000
   • Credit: GST Clearing \$100
2. Receipt (15 July 2024):
   • Debit: Bank \$1,100
   • Credit: Accrued Interest Revenue \$1,100

Reporting

• Balance Sheet: Accrued revenue is reported as a current asset.
• Income Statement: The revenue is reported in the period it was earned.

COMMON MISTAKE: Forgetting to include GST when recording accrued revenue received in a subsequent period.

Post-Adjustment Trial Balance

• Purpose: To verify that the total debits equal the total credits after balance day adjustments have been made.
• Preparation: A list of all general ledger accounts and their balances after adjustments.
• Use: Used to prepare the financial statements (Income Statement and Balance Sheet).

Ethical Considerations

• Deliberately excluding balance day adjustments to manipulate financial reports is unethical.
• Accurate and complete financial reporting is essential for informed decision-making by stakeholders.

VCAA FOCUS: Understanding the impact of balance day adjustments on the accounting equation and financial statements is crucial.