Accruals and Deferrals

Deferrals and accruals are instrumental in properly matching revenues and expenses. A deferral delays the recognition of either an expense that has been paid or a revenue that has been collected. An accrual is an expense that has not been paid or a revenue that has not yet been received.

Deferrals - Prepaid Expenses

Prepaid expenses represent the cost of goods and services purchased that are not entirely used up at the end of the year. Adjusting entries are necessary so that asset and expense accounts have the proper balances. Prepaid expenses can be initially recorded as either an asset or an expense. Either method will yield the same results, but adjusting entries to obtain the final result differ. The advantage of recording a prepaid expense initially as an asset is that no reversing entry is necessary.

Deferrals - Unearned Revenues

When revenue is received before goods are delivered or services performed, the revenue is said to be unearned. Unearned revenues can initially be recorded as either a liability or a revenue. When unearned revenues are recorded as liabilities, an unearned revenue account is credited. An advantage of this method is that no reversing entry is necessary.

When unearned income is recorded as a revenue, a revenue account is credited. This method requires a reversing entry at the beginning of the new period. Both methods produce, however, the same end result.

Accruals - Liabilities or Expenses

Many expenses which accumulate on a daily basis are only recorded at set intervals. At the end of an accounting period a portion of such expenses (for instance, salaries) often remains unpaid. Such accruals are considered to be both liabilities or expenses. An adjusting entry is necessary at the end of an accounting period to properly reflect the portion of the accrued but yet unpaid expense and liability. At the start of the next period, the adjusting entry is reversed to simplify accounting.

Accruals - Assets or Revenues

Many businesses only record revenues when they are actually received. At the end of an accounting period, all revenues earned but not yet collected require adjusting entries. The adjustment is performed by debiting an asset account and crediting a revenue account. As a result, financial statements will be able to properly match revenues and expenses. A reversing entry is performed at the first day of the new period to simplify accounting.

Reviewing Accruals and Deferrals

Although all accruals and deferrals require adjusting entries at the end of an accounting period, reversing entries are not necessary for all adjustments. Reversing entries should only be performed under the following circumstances:

1. when an accrued asset or an accrued liability is adjusted,
2. when a prepaid expense is initially recorded as an expense,
3. when an unearned revenue is initially recorded as revenue.
   

by John Petroff