Accounting for Deferrals and Accruals
I. Revenue & Expenses v. Cash Flow (a reminder)
A. Revenue/Expense AT THE SAME TIME AS the Cash Flow- Cash Transaction/COD
B. Revenue/Expense happen AFTER the Cash Flows – these are Deferrals –
cash is (usually) NOT deferred, but the Revenue or Expense IS!
C. Revenue/Expense happen BEFORE the Cash Flow – Accruals of revenue or expense
II. Deferred Revenues
A. Defined - Revenue is earned AFTER the cash (or other asset) inflow occurs.
1. We must record the receipt of cash/other asset. Theoretically, on the date the cash is
received, no revenue has been earned, but the key is WHEN do we need the
financial statements prepared and what will be the status of the amount EARNED (I/S)
vs. UNEARNED (B/S) at the time the financial reports are prepared.
a. Balance Sheet approach (usually used when you are taught the basics of
financial accounting) -- in this case, you would initially record a LIABILITY
such as UNEARNED REVENUE (a Balance Sheet account) and adjust for
the amount EARNED (Revenue) at the next balance sheet date
b. Income Statement approach - record Revenue when cash is received (hence, the
Income Statement approach) and then adjust (DEFER) for the amount that is
NOT EARNED at the next balance sheet date
2. Example: On September 1, 2009, we enter into a contract to provide consulting
services to Mrs . O. Bamma. This consulting will be done on a daily basis for the next
90 days. She agrees to prepay us the total price, $210,000 at 9-1-2009. Our
quarter ends on 9-30-09, and we need to prepare accurate financial statements.
The bookkeeper recorded the receipt of cash as revenue, per company policy.
a. Income Statement method of recording cash receipt:
…. Step 1: Where did you put the noncash portion of the entry?
…. Step 2 (analysis): How much is EARNED at 9-30? How much is unearned at 9-30?
…. Step 3: Based on steps1 and 2 above, what entry is needed at 9-30?
b. Repeat steps 1,2 and 3 using the Balance Sheet approach to record the transaction
III. Deferred Expenses
A. Defined - Expense is incurred AFTER the cash outflow occurs or, better yet
AFTER an asset is acquired and put to use, regardless of any cash flow
1. We must record the outflow of cash if spent. Theoretically, on the date the cash
is spent, no expense has been incurred, but the key is WHEN do we need the
financial statements prepared and what will be the status of the asset acquired
by the time the financial reports are prepared.
… Income Statement approach
… Balance Sheet approach
IV. IF Income Statement approach is used to record the original (cash) entry, then you MAY REVERSE the AJE; Else, do not reverse if B/S approach was used.
V. Accruals of Revenue and Expense – Easier because nothing has previously been recorded
A. Accrue Revenue with an Asset (some type of Receivable)
B. Accrue an Expense with a Liability (some type of Payable)
C. Adjusting entries for Accruals can always be reversed AFTER closing the accounts.
VI. Review
DEFER REVENUE – USE A LIABLITY (UNEARNED)
DEFER EXPENSE – USE AN ASSET many types; supplies, inventory, prepaids, PP&E etc)
ACCRUE REVENUE – USE AN ASSET (RECEIVABLE)
ACCRUE EXPENSE – USE A LIABILITY (PAYABLE)