A business received advance payments for services of $120,000 in February 2021 and it was recorded as revenue. By 30 June 2021 only 40% of the required services had been provided to the customers. To comply with the accrual accounting principle, which of the following entries is required at balance day, 30 June 2021?

Question

BlackTom AI · Accepted Answer

Context: The business initially recorded advance payments of 120,000 as revenue in February 2021. By 30 June 2021 only 40% of the services had been provided, so only 40% of the 120,000 (i.e., 48,000) should be recognized as revenue. The remaining 72,000 should be recorded as a liability (unearned revenue) until the services are delivered. The journal entry needed at balance day is a reversal of the portion previously recognized as revenue and a transfer to unearned revenue.

Option a: Decrease Unearned Revenue $48,000; Increase Fees Revenue $48,000. Explanation: This would imply moving 48,000 from unearned revenue to revenue. However, the correct adjustment is to reclassify 72,000 (not 48,000) because 72,000 of the advance payment remains unearned at 30 June. This option understates the liability reversal and overstates the revenue reclassification consistency with the 40% completion.

Option b: Decrease Fees $72,000; Increase Unearned Revenue $72,000. Explanation: This entry debits Fees Revenue by 72,000 (a reduction of previously recognized revenue) and credits Unearned Revenue by 72,000 (recognizing the amount still unearned). This aligns with the need to reduce the over-recorded revenue from the advance and to reclassify the remaining 72,000 as a liability, leaving 48,000 as earned revenue in total. It matches the 40% completion and the 120,000 original advance.

Option c: Increase Accrued Revenue $48,000; Increase Fees Revenue $48,000. Explanation: Accrued revenue would imply revenue earned but not yet billed or received, which is not the issue here. The problem involves correcting an overstatement of revenue and reclassifying the unearned portion, not recording additional earned revenue through accrual.

Option d: Increase Bank $120,000; Decrease Accrued Revenue $48,000; Credit Unearned Revenue $72,000. Explanation: This option introduces cash effects and a decrease in accrued revenue, which do not reflect the reversal of previously recorded revenue and the proper reclassification. It inconsistently combines cash with accrual adjustments and the split of the 120,000 into different components.

Option e: Decrease Unearned Revenue $72,000; Increase Fees Revenue $72,000. Explanation: This would move 72,000 from unearned revenue to revenue, which is the opposite of what is required. Since 72,000 remains unearned, we should increase unearned revenue (not decrease it) and decrease revenue accordingly.

Summary: The appropriate adjustment is to reduce the previously recorded revenue by 72,000 and to increase unearned revenue by 72,000, reflecting that only 48,000 has been earned by 30 June and 72,000 remains as a liability for future service delivery. Among the options, option b implements this correction by debiting Fees Revenue for 72,000 and crediting Unearned Revenue for 72,000, aligning with accrual accounting principles and the service completion status.

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