Raquel C.

Arnold Managerial Accounting Assignment # 6

Assignment # 6

Raquel C. Arnold

MBA, Managerial Accounting

Metropolitan College of New York

This Paper was written for

MBA 615 SKI – Managerial Accounting, course Instructor Emerson Nobbee

Raquel C. Arnold Managerial Accounting Assignment # 6

Assignment # 6

1. What is the purpose of deferrals and accruals?

An accrual brings forward an accounting transaction and recognizes it in the current period even

if the expense or revenue has not yet been paid or received. A deferral method postpones

recognition until payment is made or received.

2. What are prepaid expenses? Give examples.

A prepaid expense is an expense that has been paid for in advance but has not yet been incurred.

In business, a prepaid expense is recorded as an asset on the balance sheet that results from a

business making advance payments for goods or services to be received in the future.

Prepaid expenses are initially recorded as assets, but their value is expensed over time onto the

income statement. Unlike conventional expenses, the business will receive something of value

from the prepaid expense over the course of several accounting periods.

For example, assume ABC Company purchases insurance for the upcoming 12-month period. It

pays $120,000 upfront for the insurance policy. ABC Company will initially book the full

$120,000 as a debit to prepaid insurance, an asset on the balance sheet, and a credit to cash.

Each month, an adjusting entry will be made to expense $10,000 (1/12 of the prepaid amount) to

the income statement through a credit to prepaid insurance and a debit to insurance expense. In

the 12th month, the final $10,000 will be fully expensed and the prepaid account will be zero.

3. What is unearned revenue? Give examples.

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Unearned revenue is money received by an individual or company for a service or product that

has yet to be provided or delivered. It can be thought of as a "prepayment" for goods or services

that a person or company is expected to supply to the purchaser later. As a result of this

prepayment, the seller has a liability equal to the revenue earned until the good or service is

delivered. This liability is noted under current liabilities, as it is expected to be settled within a

year. Unearned revenue is also referred to as deferred revenue and advance payments.

For example: Morningstar Inc. offers a line of products and services for the financial industry,

including financial advisors and asset managers. Many of its products are sold through

subscriptions. Under this arrangement, many subscribers pay upfront and receive the product

over time. This creates a situation in which the amount is recorded as unearned revenue or, as

Morningstar calls it, deferred revenue. At the end of the second quarter of 2020, Morningstar had

$287 million in unearned revenue, up from $250 million from the prior year end. The company

classifies the revenue as a short-term liability, meaning it expects the amount to be paid over one

year for services to be provided over the same period. Unearned revenue can provide clues into

future revenue, although investors should note the balance change could be due to a change in

the business. Morningstar increased quarterly and monthly invoices but is less reliant on up-front

payments from annual invoices, meaning the balance has been growing more slowly than in the

past.

4. What accruals related to liabilities are usually necessary?

Accrued liability is an expense incurred but not yet paid for by a business. These are costs for

goods and services already delivered to a company for which it must pay in the future. A
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company can accrue liabilities for any number of obligations, and these are recorded on the

company's balance sheet. They are normally listed on the balance sheet as current liabilities and

are adjusted at the end of an accounting period. An accrued liability is a financial obligation that

a company incurs during a given accounting period. Although the goods and services may

already have been delivered, the company has not yet paid for them in that period. They are also

not recorded in the company's general ledger.1 Although the cash flow has yet to occur, the

company must still pay for the benefit received. Accrued liabilities, which are also called accrued

expenses, only exist when using an accrual method of accounting.2 The concept of an accrued

liability relates to timing and the matching principle. Under accrual accounting, all expenses are

to be recorded in financial statements in the period in which they are incurred, which may differ

from the period in which they are paid. The expenses are recorded in the same period when

related revenues are reported to provide financial statement users with accurate information

regarding the costs required to generate revenue. The cash basis or cash method is an alternative

way to record expenses. But it doesn't accrue liabilities. Accrued liabilities are entered into the

financial records during one period and are typically reversed in the next when paid. This allows

for the actual expense to be recorded at the accurate dollar amount when payment is made in full.

5. What accruals related to assets or revenuew are usually necessary?

Accruals are needed for any revenue earned or expense incurred, for which cash has not yet been

exchanged. Accruals improves the quality of information on financial statements by adding

useful information about short-term credit extended to customers and upcoming liabilities owed

to lenders.

6. Do accruals and deferrals require year end adjusting entries?

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Generally, adjusting journal entries are made for accruals and deferrals, as well as estimates.

Sometimes, they are also used to correct accounting mistakes or adjust the estimates that were

previously made. Adjusting journal entries are recorded in a company's general ledger at the end

of an accounting period to abide by the matching and revenue recognition principles. The most

common types of adjusting journal entries are accruals, deferrals, and estimates.

7. What happens to deferrals and accruals at the beginning of the year?

Under GAAP and IAS / IFRS, businesses are required to adopt accrual basis accounting when

preparing accounting information. Accrual basis accounting - revenue is recognized when

earned, and expenses are recognized when incurred regardless of when cash is received or paid.

Types of periods - end adjustments Typically there are 5 types of adjustments (all to be prepared

at the accounting year end or month end):

 Converting assets to expenses - prepaid items, supplies expense, depreciation expenses

etc.

 Converting liabilities to revenue - unearned revenues

 Accruing unpaid expenses - salaries expenses incurred but to be paid next year

 Accruing uncollected revenues - goods sold to customers but to be received next year

 Year-end estimates - tax expense: Please note that period-end adjustments could be made

monthly or annually.

1. Converting assets to expenses: This includes prepaid items, supplies expense, and

depreciation expenses. For example, if a company pays for insurance in advance, it's

initially recorded as an asset prepaid insurance.

2. Converting liabilities to revenue: This includes unearned revenues.

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3. Accruing unpaid expenses: This includes expenses like salaries that have been incurred

but will be paid in the next accounting period.

4. Accruing uncollected revenues: This includes revenue from goods sold to customers, but

payment will be received in the next accounting period.

5. Year-end estimates: This includes expenses like tax that are estimated for the year-end.

These adjustments ensure that the financial statements accurately reflect the company's

financial position and performance for the period.