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Accruals and Deferrals

Accruals and deferrals are accounting adjustments used to properly record revenues and expenses in the periods they are earned or incurred, rather than when cash is received or paid. Accruals occur before cash changes hands to record unpaid revenue or expenses, while deferrals happen after cash is received or paid to allocate amounts over multiple periods. Examples include accruing interest earned but not received, accruing unpaid wages as an expense, deferring prepaid rent over several months, and deferring upfront customer payments as unearned revenue. Incorrect use of accruals and deferrals can distort financial reporting.

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406 views2 pages

Accruals and Deferrals

Accruals and deferrals are accounting adjustments used to properly record revenues and expenses in the periods they are earned or incurred, rather than when cash is received or paid. Accruals occur before cash changes hands to record unpaid revenue or expenses, while deferrals happen after cash is received or paid to allocate amounts over multiple periods. Examples include accruing interest earned but not received, accruing unpaid wages as an expense, deferring prepaid rent over several months, and deferring upfront customer payments as unearned revenue. Incorrect use of accruals and deferrals can distort financial reporting.

Uploaded by

ravisankar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Accruals and Deferrals

Business performance may be distorted by incorrect accruals and


deferrals adjustments
In order to comply with the revenue recognition and matching principles, revenues and expenses have to
be reported in the time period in which they are earned or incurred. Accruals and deferrals are
instrumental in helping this proper reporting of revenues and expenses happen. Accruals and deferrals
require adjusting entries at the end of the accounting period.

Accruals and deferrals occur only when a business uses accrual-based accounting methods. If accruals
and deferrals are not used correctly in the accounting cycle, certain accounts may seem undervalued or
overvalued.

Under the accruals, conditions are satisfied to record a revenue or expense, but money has not changed
hands yet. An accrual occurs before a payment or receipt.

Under the deferrals, money has changed hands, but conditions are not yet satisfied to record a revenue
or expense. A deferral occurs after a payment or receipt.

Accrued Revenue

Accrued revenue is entered into an accounting journal once the revenue is earned regardless of whether
a business has received the physical cash. For instance, if your business performs a service for a client,
you have earned the revenue for that service. Before you receive the cash, the revenue is entered into an
accrued revenue account. After you receive cash from your client, the accrued revenue account is
decreased by the amount of cash received.

An accrual of revenues refers to the reporting of revenues and the related receivables in the period in
which they are earned, and that period is prior to the period of the cash receipt. An example of the accrual
of revenues is the interest earned in December on an investment in a government bond, but the interest
will not be received until January.

Accrued Expenses
Accrued expenses are noted at the time they occur, regardless of whether your business has paid them.
For example, you know that you have to pay employees at the end of the month before you actually write
checks. The expense is entered into an accrued expenses account as a liability, then when your business
writes employee checks, the accrued expense is zeroed out and cash assets decrease.

An accrual of an expense refers to the reporting of an expense and the related liability in the period in
which they occur, and that period is prior to the period in which the payment is made. An example of an
accrual for an expense is the electricity that is used in December, but the payment will not be made until
January.

Deferred Revenue (Unearned Revenue)

Revenue deferrals are used by accountants to spread out revenue over time. For example, your business
may enter into an agreement with a client to perform a service over a period of time. However, the client
may pay you the entire amount for the service up front. If this occurs, you would enter the lump payment
into a deferred revenue account and spread the revenue over the fiscal period. For instance, if a
customer pays $100 upfront for two months of service, you would put the $100 into a deferred revenue
account and subtract $50 from the account each month. The subtracted amounts would go to your
company's cash holdings.

A deferral of revenues refers to receipts in one accounting period, but they will be earned in future
accounting periods. For example, the insurance company has a cash receipt in December for a six-month
insurance premium. However, the insurance company will report this as part of its revenues in January
through June.

Deferred Expenses (Prepaid Expenses)

Deferred expenses are spread out over the period to which they apply. When you prepay expenses -- for
rent or other items -- the entire sum is taken from your assets. For example, if you pay $6,000 for six
months of rent upfront, you put the $6,000 into a deferred expense account and debit the account $1,000
each month for six months. Deferring expenses helps businesses keep track of their expense cash flows
and gives a more accurate picture of quarterly performance.

A deferral of an expense refers to a payment that was made in one period, but will be reported as an
expense in a later period. An example is the payment in December for the six-month insurance premium
that will be reported as an expense in the months of January through June.

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