Chapter 5
The Accounting Cycle: Adjustments
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Once the contract is completed on October 20, you can bill the client. If they pay you immediately,
you will receive the full $6,000 cash. You will only record $4,000 worth of revenue earned for the
month of October since the other $2,000 worth of revenue was already recorded on September 30.
There will also be a $2,000 decrease to accounts receivable to indicate that the client has now paid
you the amount owed.This is illustrated in Figure 5.3.
In most cases, sales are entered from a sales invoice directly into the accounting records, without
looking back to see if there were any adjustments made in the previous period. Thus, the transaction
on October 20 could be recorded incorrectly if the adjusted amount in accounts receivable is
forgotten and not applied to the transaction. If accounts receivable is not applied, $6,000 would be recorded
as service revenue for October instead of $4,000. To eliminate the risk of forgetting about the adjustment
for accrued revenue and making an error, an optional step is to record a reversing entry. This would be done
on the first day of the new accounting period; in this example it would be made on October 1, 2016 so it
would not affect the reporting in September. The reversing entry would be the opposite of the adjustment
on September 30, 2016.
Oct 1 Service Revenue
2,000
Accounts Receivable
2,000
By creating this reversing entry, the effect of the adjustment of the previous month is undone for the current
month and leaves the revenue account with a negative (debit) balance of $2,000. On October 20, the full
amount of the contract of $6,000 can be recorded, but since service revenue already has a negative balance
of $2,000, only $4,000 of revenue will be recognized in the month of October.
Oct 20 Cash
6,000
Service Revenue
6,000
It is important to note that a reversing entry is just an option businesses can use to make their bookkeeping
easier. It does not change anything about the accrual-based accounting and it typically occurs only at the
beginning of an accounting period.
INTHE REAL WORLD
accrued expenses
Similar to accrued revenue,
accrued expenses
are expenses that have been incurred but have not
yet been recorded. Examples of expenses that may accrue at month end include property taxes,
salaries, interest on a loan and rent. In some cases, a business may have to estimate the accrued
journal
Page 1
date
2016
account title and explanation Pr debit credit
Oct 20 Cash
6,000
Accounts Receivable
2,000
Service Revenue
4,000
To record collection from client
____________
FIGURE 5.3
BALANCE SHEET
LIABILITIES
ACCOUNTS
PAYABLE
UNEARNED
REVENUE
LOAN PAYABLE
INCOME STATEMENT
EXPENSES
SERVICE REVENUE
DEPRECIATION
INSURANCE
SALARIES
RENT
Owner’s equity increases by $4,000
ASSETS
CASH
OFFICE
SUPPLIES
ACCOUNTS
RECEIVABLE
- $2,000 CR
+ $6,000 DR
+ $4,000 CR
