An adjusting entry, often referred to as a balance day adjustment, forms part of financial reporting under accrual accounting systems. Today, we will be looking at accrued revenue and its adjusting entry when preparing period-end accounts.
The quick answer to which accounts to use is debit an accrued revenue asset account and credit a corresponding revenue account. If you would like a fuller explanation, please read on.
What is an Accrued Revenue Adjusting Entry?
Accrued revenue occurs at the end of a reporting period for income that has been earned, i.e. the work has been carried out, but either the client has not been invoiced, or payment has not been received. This is not to be confused with credit sales, where the work has been performed (the good or service has been provided to the client) AND the client has been sent an invoice. You would record this type of transaction through the sales ledger.
However, we have a situation where the reporting entity has provided the good or service and is yet to record the revenue (usually because the client hasn’t been sent an invoice). But of course, this only occurs under accrual accounting systems, not cash-based systems. Under accrual systems, we measure the flow of economic resources (nowadays referred to in accounting standards as economic benefits or obligations). Whereas under a cash-based system, we are reflecting the movement of cash.
What is an Adjusting Entry?
So why do we require these adjusting entries? In the “old days,” it was because of the matching concept. I say the “old days” because conceptual accounting frameworks, particularly those issued by the International Financial Reporting Standards (IFRS), have moved away from focusing on the income statement to the balance sheet. Therefore, accounting is now more focused on assets and liabilities rather than income and expenditure.
In our case, we bring accrued revenue to account as an adjusting entry not because of the revenue side but rather because it falls within the definition of an asset for the reporting entity.
The IFRS define an asset as “… a present economic resource controlled by the entity as a result of past events” (para 4.3). With accrued revenue, the reporting entity is owed an economic resource (usually money) for its carried out (past event).
Accrued Revenue Adjusting Entry Example
Now that we have covered the accounting concepts behind accrued revenue, let’s move onto a practice example with a few journal entries. Let’s say ABC Home Decorating Ltd is approaching year-end, March 31, and one of its small house decorating jobs has just been completed – being $6,500. And let’s say ABC issues the invoice for the work on April 5.
Balance Day Adjustment
In this case, for the year-end reporting, assuming ABC is operating an accrual accounting system, we need to raise a balance-day adjustment for the work completed. The entry would be:
|31 March||Accrued Revenue||$6,500|||
So in ABC’s set of accounts ending 31 March, the above journal entry has increased current assets with the debit to accrued revenue and increased revenue with the credit to contract revenue. This entry ensures ABC’s financial statements reflect these economic benefits as of 31 March.
Balance Day Adjustment Reversal
Come the start of the new year, April 1, and ABC needs to reverse out adjusting-entry. The reversal ensures the accounting system is “clean” of adjustments, and the system doesn’t leave them floating around. So ABC would post the following entry:
|1 April||Contract Revenue||$6,500|||
Invoice Issued and Payment
When ABC issues the invoice on April 5, they will make the following entry in their sales ledger (assuming they are operating a subsidiary sales ledger):
This entry increases current assets with a debit entry to debtors and increases income with a credit entry to contract revenue.
When the client pays the account, the last entry required for this contract would be:
The final entry increases current assets with a debit to the bank, being the client’s money at the end of April. But at the same time decreases current assets by the same amount as the debtor balance has been paid and is no longer owed to ABC.
That brings us to the end of another accounting tutorial, looking at the accrued revenue adjusting entry and then the journal entries involved to reflect it in a reporting entity’s books adequately.