1. Balance Day Adjustments
Mary Low
Waikato Management School
The University of Waikato
© Mary Low

2. Profit Measurement Profits are important
for a business to succeed and survive.
Accounting helps businesses to
measure and report the success or failure of businesses achieving this profitability goal.
Profits:
increase owner’s equity
is reported in the Income Statement (Performance Statement)
is a measure of business performance
Because profit measurement is important for critical decision making,
the measurement of net profit has to be done in accordance with GAAPs.
© Mary Low

3. Accrual Basis Accounting
Accrual Basis Accounting is required under GAAPs and the New Zealand Framework for the preparation of financial statements for decision making purposes.
Accrual accounting attempts to record the financial effects of transactions relating to the accounting periods for which those transactions occur.
Accrual accounting involves:
recording revenues (income) when earned and expenses when incurred and
adjusting the accounts to ensure that transactions are identified appropriately according to the accounting period.
For example: A credit sale made in 2006 for which money will be received in 2007.
Accrual basis accounting practice will recognise the credit sale as 2006 revenues (income) earned for the accounting period ended 2006.
The Cash basis accounting, however will recognise that revenues have been earned in 2007 when cash will be received
© Mary Low

4. Accrual Basis Accounting
The accrual basis accounting method
the effect of the transactions is recognised in the accounting period in which the transaction takes place, irrespective of when cash is to be received or paid.
Financial statements prepared using accrual based accounting
correctly match the income with all associated costs that help to produce that income.
© Mary Low

5. Balance Day Adjustments
Balance day adjustments are therefore required to ensure the financial statements portray a correct picture of the firm’s financial performance and financial position.
We have to recognise all transactions occurring in that accounting period, irrespective of whether cash has been received or paid.
The ultimate objective of adjusting entries is to ensure that the revenues (income) earned in the accounting period are matched by all costs incurred for that same accounting period.
If this is not done, the end result would be:
a distorted profit picture because:
Revenue (income) may be understated or overstated,
Expenses may be understated or overstated,
Assets and Liabilities of the firm may also be overstated or understated.
Equity also being understated or overstated as a result of a distorted profit picture.
© Mary Low

6. Three major categories of balance day adjustments
Correction of Errors
Errors may have been made in the recording process but their effects were not identified in the trial balance.
Accruals
This type of adjustment relates to transactions occurring in the current accounting period but the effects of which are not yet recorded and recognised in the accounting period.
Two types of accruals:
accrued revenues (income) and
accrued expenses
Deferrals
This category of adjustments aligns recorded revenues (income) and costs with appropriate accounting periods.
For example, there are situations where cash is received before goods and services are provided to customers or situations where cash has been paid in advance for costs of operation and which relate to future accounting periods.
Two types of deferrals are:
Income in Advance (Unearned Revenue)
Prepayments (Prepaid Expense)
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7. Depreciation as a balance day adjustment
Property, plant and equipment assets are acquired for the purpose of helping the business to generate income.
The purchase of property, plant and equipment for use in the business are recorded as assets.
The assets are usually used by the firm for more than one accounting period.
The effect of purchasing property, plant and equipment can be likened to a big prepaid expenditure [i.e. a deferral]
The cost of holding this asset should be spread over the accounting periods in which it helps to produce income.
This cost allocation is known as depreciation.
Depreciation estimates are usually done at the end of an accounting period and therefore viewed as as a balance day adjustment.
© Mary Low

8. Balance Day Adjustments Illustrations
Accruals
Deferrals
Depreciation
Correction of errors
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9. Year-end information made available Type of adjustment required
Type of Accounts affected
Adjusting journal entry
At the end of the year, wages payable of $2,600 had not been recorded or paid.
Accrual adjustment - Accrued Expense (Expense Payable)
Expense to be increased
Liability to be increased
There is no GST implication on wages.
Wages Expense Dr $2,600
Wages Payable Cr $2,600
Interest of $250 on a bill receivable was earned at year-end, although collection of the interest was not due until the following year.
Accrual adjustment - Accrued Income (Income Receivable)
Asset to be increased
Revenue (income) to be increased
There is no GST implication on Interest Revenue on a bill receivable.
Income Receivable Dr $250
Interest Revenue Cr $250
© Mary Low

10. Year-end information made available Type of adjustment required
Type of Accounts affected
Adjusting journal entry
The unadjusted Prepaid Insurance balance (GST exclusive) at year end was $4,000. It was determined that $1,800 of the prepaid insurance balance had expired for the accounting period just ended.
Deferral adjustment – Prepayment (Prepaid Expense)
Asset to be decreased
Expense to be increased
There is no GST implication on the Prepaid Insurance adjustment because the GST implication on this item would have been accounted for the payment of prepaid insurance was initially recorded.
Insurance Expense Dr $1,800
Prepaid Insurance Cr $1,800
At the end of the year, $2,700 (GST inclusive) was collected in cash for service revenue to be provided in the next accounting period.
Deferral adjustment – Income in Advance (Unearned Revenues)
Asset to be increased
Liability to be increased
GST Payable (Liability) to be increased
The GST implication of receiving cash for unearned revenues has to be accounted in this period because the GST has been collected in cash and is therefore payable to the IRD.
Cash Asset Dr $2,700
Income in Advance Cr $2,400 GST Payable Cr $300
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11. Year-end information made available Type of adjustment required
Type of Accounts affected
Adjusting journal entry
The annual depreciation on equipment for the accounting period just ended was estimated to $4,500.
Estimation of Depreciation
Expense to be increased
Asset (Contra) to be increased
There is no GST implication on the depreciation estimate adjustment because the assets are recorded at GST exclusive cost
Depreciation on Equipment Dr $4,500
Accumulated Depreciation on Equipment Cr $4,500
An amount of $360 (GST inclusive) for payment of Electricity expense was wrongly recorded as Equipment asset.
Correction of error
Asset to be decreased
There is no need to make a correcting entry for GST as the $40 GST Receivable (amount that can be claimed back from the IRD) will have been correctly debited. The credit entry made to the Cash account will not need correcting either.
Electricity Expense Dr $320
Equipment Asset Cr $320
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