Chapter 16
Balance Day Adjustments - Revenues
 Balance
day adjustments are made to ensure
that revenue accounts show revenues earned
and expense accounts show expenses
incurred in a particular Reporting period, so
an accurate profit can be calculated.

So far we have covered balance day adjustments
to ensure that expense accounts show the
amounts incurred/consumed:
stock losses (Chapter 8)
 prepaid expenses and accrued expenses (Chapter
10)
 depreciation (Chapter 11).

(The only exception is a Stock gain.)
 In this chapter, we will cover balance day
adjustments to ensure that revenue accounts
show the amounts earned:
prepaid revenues
 accrued revenues.

 Revenue
is not necessarily cash. The key is
that some type of economic benefit has been
received (either by assets increasing or
liabilities decreasing), and that owner’s
equity has increased as a consequence.
 Do Revenue Question 16.1.

Q 3.
 Although
perhaps less frequent than a
prepaid expense, it is possible for a firm to
receive revenue in advance of supplying the
goods. This would be the case for a lay-by, or
if a firm accepted subscriptions (for
example, to a magazine), or rented out extra
space in its warehouse. In cases such as
these, the firm would have received the
cash, but because it has not supplied any
goods (or services) to the customer, it has
not earned any revenue.
 This means the receipt is prepaid revenue,
or revenue received in advance.
 Where
revenue is prepaid, the good/service
is owed to the customer, so the firm has an
obligation to provide them sometime in the
future. Thus prepaid revenue is not revenue
at all, but rather a current liability – a
present obligation that is expected to result
in an outflow of economic benefits when the
good/service is supplied sometime in the
next 12 months.
 When
revenue is received in advance – or
prepaid – it must be recorded as a current
liability in the journals and ledger accounts.
 See Journal, General Ledger entries p. 370.
 Of the $462 cash received from the courier
company, $42 is GST that is now owed to the
ATO, but the remaining $420 is Prepaid rent
revenue – the use of the office space which is
owed to the courier company.
 Note that there is no effect on owner’s
equity whatsoever, so the cash received
cannot be revenue.


Prepaid revenues are recorded as current liabilities
because when the cash is received, none of the amount
has been earned – it is a present obligation to provide the
good or service. However, if by balance day the
good/service has been provided to the customer, then the
firm will have fulfilled its obligation. That is, the liability
has been extinguished, so the revenue has been earned.
(This is a very good example of a revenue in the form of a
decrease in a liability – Prepaid revenue – rather than the
usual increase in assets created by a cash or credit sale.)
It is therefore necessary to adjust the ledger accounts so
that:


the amount earned in the current Reporting period is shown
as a revenue
the Prepaid revenue account only shows the amount
remaining (i.e., unearned, or to be earned in a future
Reporting period).
 See
Bag Emporium example.
 The balance day adjustment to record the
prepaid rent revenue earned is shown in the
General Journal entry in Figure 16.1. See
also General Ledger.
 As a consequence of the balance day
adjustment, a liability becomes a revenue,
decreasing liabilities and increasing owner’s
equity. Assets do not change at all.
 The
adjusted figure in the revenue account
can now be closed to the Profit and Loss
Summary account. Remember, all revenue
accounts are closed in one General Journal
entry, with each revenue account debited to
reduce its balance to zero, and one credit to
the Profit and Loss Summary account.
 See Rent Revenue account on p.371.
 The
entries detailed above apply to all
prepaid revenues, but Prepaid sales revenue
is a particular type of prepaid revenue: it
involves the provision of stock. As a result,
the recording of Prepaid sales revenue
requires the entries in Figure 16.1, with one
additional step: stock must also be adjusted.
Prepaid sales might occur when a new
product is released; customers might pay in
advance to ensure they are among the first
to have them.
 See Cash Receipts Journal and General
Ledger in text.




Our example stated that $900 has been received, but
not yet earned. What happens when the goods are
supplied?
Because the goods have been provided to the
customer, the liability has decreased, meaning the
revenue has now been earned.
The balance day adjustment to record the prepaid
sales revenue earned is shown in the General Journal
entry in Figure 16.2.
Like any adjustment for prepaid revenue earned, this
entry credits the Revenue account and debits the
Prepaid revenue account $900. However, like any
sale, this entry also has a cost price entry: debit Cost
of sales, credit Stock Control ($360). (The entry in
the stock card would take place when the goods are
provided, not when the cash is received.)
 See
General Ledger p. 371.
 Note: The two entries in the Cost of sales
account reflect the cost price of cash sales
($15 000 from the Cash Receipts Journal),
and the cost price of the goods which were
prepaid and then sold ($360 from the
General Journal).
 Review

Questions 16.3.
Q’s 2 & 3.

Prepaid revenues are received before they are
earned, but in some cases revenues will be
received after they are earned. For example,
interest on a term deposit may have been
earned, but is not due to be received until next
month. Other items like royalties and
commissions may only be received after they
have been earned. Because this amount has been
earned in the current Reporting period, it must
be recognised as revenue. In addition, the
amount owing should also be recorded as a
current asset, as some time in the future, the
cash will be received. The amount owed to us
for revenue we have already earned is called
accrued revenue.

Accrued revenue and debtors are similar in that
they are assets. In both cases the revenue is
earned before the cash is received, so they
represent a resource controlled by the entity
(the debt owed to the business), which will bring
a future economic benefit in the next 12 months
(when the cash is received). However, they are
different in a subtle but important way. If the
customer has the goods and the invoice, then a
credit sale has occurred, and a debtor should be
recognised. However, if the revenue relates to a
transaction other than sales, and the customer
has not been sent the invoice, then accrued
revenue has been earned. (As such, accrued
revenue will be verified by a memo rather than
an invoice).
 Prior
to making any balance day
adjustments, the revenue accounts will only
show the amounts received.
 See Kilvington Kites example p. 376.
 Between 31 January 2015 (when the first six
months of interest is received) and 30 June
2015 (when the firm’s reports are prepared),
there are five months, and in those five
months, the firm has earned five months’
worth of interest revenue. This cash
therefore must be added to the revenue
account.

It is therefore necessary to adjust the ledger accounts so
that:
the extra amount earned in the current Reporting period is
added to the revenue account
 a current asset account – Accrued revenue – is created to
show the amount owing to us (which will be received in the
next Reporting period).


By balance day, the firm has earned an extra $375
worth of interest revenue that it is yet to receive
(Memo 8).

The balance day adjustment to record the accrued interest
revenue is shown in the General Journal entry in Figure
16.3. See also General Ledger. Note that the amount used
in the adjustment ($375) is not the total revenue for the
period, it is simply the amount owing. It is added to the
amount received to calculate the total revenue earned of
$825.
 As
a current asset, the Accrued interest
revenue account will be balanced, but the
Interest revenue account will be closed to
the Profit and Loss Summary account. See p.
378.
 Remember, for an item to be recognised as
revenue, the definition requires an item to
be earned; the receipt of cash is not
necessary.


Sometime in the next Reporting period, the amount
owing to us as accrued revenue will be received.
Therefore, when the cash is received, some may
represent a revenue of the current Reporting period,
but at least some of the receipt will relate to the
previous Reporting period. In other words, some of
the amount received reduces the asset – Accrued
revenue.
In our example, on 30 June 2015, we created a
current asset – Accrued interest revenue – to
represent the $375 worth of interest we had earned,
but not yet received. That is, we have already
counted it as revenue. When the second installment
of interest of $450 is received on 31 July 2015 (Rec.
78), we cannot count it as revenue a second time!

When the cash is received, we must recognise that of
the $450 received:



$375 was earned in a previous Reporting period, so it is
not revenue in the current period, but rather a
reduction in the current asset Accrued interest revenue
only the remaining $75 ($450 received – $375 accrued
revenue = $75) represents revenue earned in the current
Reporting period.
The receipt of interest on 31 July 2015 would be
recorded in the Cash Receipts Journal as shown
in Figure 16.4. The $450 receipt is split; $375
relates to interest which was earned in (and adjusted
at the end of) June. This part of the receipt
decreases Accrued interest revenue. The remaining
$75 is interest earned in the current period.
 Refer
General Ledger p. 380.
 GST on receipt of accrued revenues
 In the event that GST applies to the receipt
of accrued revenue, it is only the non-GST
amount that would be allocated
between the revenue and accrued
revenue accounts. In our example, it
would be recorded in the Cash Receipts
Journal as shown on p.380.
 Review

Questions 16.4.
All q’s.
 Read
Summary.
 Read Chapter 17 Where are We Headed?