An adjusting entry, or often referred to as a balance day adjustment, forms part of financial reporting under accrual accounting systems. Today we are going to be looking at accrued revenue and what adjusting entry is required when preparing period-end accounts.
The quick answer to the question is you need to raise a debit to an accrued revenue asset account and a credit to a corresponding revenue income. 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, ie 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 invoiced for the work. This type of transaction would be recorded through the sales ledger.
However in our case we have a situation where the reporting entity has provided the good or service but the sale has yet to be recorded (normally because an invoice has not been issued).
But of course this only occurs under accrual accounting systems, not cash based systems. The reason being under accrual systems we are measuring the flow of economic resources (now days referred to in accounting standards as economic benefits or obligations). Where as under a cash based system … yes, we are just 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 accounting conceptual frameworks, in particular that issued by the International Financial Reporting Standards (IFRS), have moved away from a focus on the income statement to the balance sheet. This means they are now more focused on assets and liabilities rather than income and expenditure.
In our case accrued revenue is brought to account as an adjusting entry not because of the revenue side (and therefore the “matching” of the associated expenditure incurred), 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 (normally money) for work it has carried out (past event).
Accrued Revenue Adjusting Entry Example
Now that we have covered-off 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 it’s small house decorating jobs has just been completed – being $6,500. And let’s say the invoice for the work isn’t issued until April 5.
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 a credit to contract revenue. This entry ensures the economic benefits owed to ABC as at 31 March are appropriately reflected in their financial statements.
Come the start of the new year, April 1, the above adjusting-entry needs to be reversed out. This is done to ensure the accounting system is kept “clean” of adjustments at set times and these items are not forgotten later on. So ABC would post the following entry:
|1 April||Contract Revenue||$6,500|||
When the invoice is issued on April 5 the following entry would be made in their sales ledger (assuming they are operating a subsidiary sales ledger):
This entry increases current assets again; this time a debit to debtors and an increase in income with a credit to contract revenue.
And when the account is paid by the client the last entry required for this contact would be:
The final entry increases current assets with a debit to bank, being the money received from the client 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 no longer owed to ABC.
That brings us to the end of another accounting tutorial, this time looking at what the accrued revenue adjusting entry is and then the journal entries involved to properly reflect it in a reporting entity’s books.