Accounting for Accruals and Deferrals – What are they and why do we do them?

Each year, the University is required to issue a report on its financial condition for use by a broad audience, including the federal government, the Massachusetts Attorney General’s Office, rating agencies, bondholders, donors, and alumni. This report includes a balance sheet and a change in net assets statement (the non-profit equivalent of a profit-and-loss statement). These financial statements must be produced in compliance with “Generally Accepted Accounting Principles” (GAAP).

GAAP requires that the University include in its financial statements expenses that are incurred during the year, as well as income earned during the year. As such, there may be transactions that occur in the following fiscal year that must be reported in the current fiscal year. To accomplish this, we process “accruals” for payables that are outstanding at June 30th, “receivables” for income that is outstanding but earned, as well as entries for “deferred” revenue and “prepaid” expenses. To ensure accurate financial statements, we are required to record these adjustments for all “material” transactions. In general, these entries are processed by a tub’s central financial office, although the central tub office often relies upon departmental administrators to provide information needed to complete these entries.

When you pay a bill, the expense is recorded in the General Ledger; when you receive a payment for a service or good, the income is recorded in the General Ledger. At the end of each year, we need to make sure that expenses are recorded for all goods or services you have received during the year. We also need to make sure income is recorded for all goods or services you have provided during the year.

It is important to note that these adjustments only relate to transactions involving parties external to Harvard (i.e. affiliated hospitals, other universities, corporations). They are not made for transactions between and/or within tubs.

To ensure expenses and income are recorded in the proper year, the following adjustments are required:

  • For expenses:
  • An entry should be recorded when a good or service has been received in the current fiscal year but will not be paid for prior to year-end. This entry is called an accounts payable (A/P) accrual; it debits/charges expense for the related amount and credits accounts payable on our balance sheet.
  • An entry should be recorded when a bill has been paid in the current fiscal year for a good or service that will not be received until the next fiscal year. This entry records a prepaid expense; it debits/charges a prepaid expense object code on the balance sheet and credits the expense object code from which the bill was paid. (Note that this entry is not necessary if the original bill is charged directly to the prepaid expense object code.)
  • For income:
  • An entry should be made when a tub has not received income owed to it by year-end for goods or services provided by the tub during the current fiscal year. This entry is called an accounts receivable (A/R) accrual; it debits/charges an accounts receivable object code on the balance sheet and credits the appropriate income object code.
  • An entry should be recorded when revenue has been received in the current fiscal year but the tub will not be providing the good or service until the next fiscal year. This entry records deferred revenue (“unearned income” that should be included in income in the following year); it debits/charges the income object code where the revenue has already been recorded and credits a deferred revenue object code on the balance sheet. (Note that this entry is not necessary if the original receipt is credited directly to the deferred revenue object code.)

In short, these adjustments allow expenses to be reported when incurred, not paid, and income to be reported when it is earned, not received.

The following are general rules regarding A/P (expense) accruals:

  • Accounts payable accruals should be made for items where a good or service has been received in the current fiscal year but will not be paid for prior to year-end. This includes items for which an invoice has been received but not paid, as well as items for which an invoice has not yet been received. If an invoice has not been received, then the department should process the accrual based either upon the known cost or an estimated cost if one can reasonably be calculated. Any such costs that are for $10,000 or more for non-CIP items and $1,000,000 or more for CIP items must be accrued.
  • Departments should not delay processing these expenses because of a lack of funding. Departments should consult with their financial office if there is a funding issue.
  • No accruals using sponsored funds can be processed.
  • Example:

A department orders and receives two computers at the end of June. However, the bill is not received until July and is not processed until August. Because the computers were received in June, an A/P accrual journal for these expenses should be processed. This accrual would debit/charge the appropriate 33-digit expense coding and would credit the balance sheet accounts payable liability coding.

The following are general rules regarding prepaid expenses:

  • Prepaid expenses should be recorded for non-sponsored research fundeditems where a bill has been paid in the current fiscal year for a good or service that will not be received until the next fiscal year. Prior to year-end, the department should determine what expenses have been paid for goods or services that will not be received until after June 30th. Any such amounts that are for $10,000 or more must be recorded as prepaid expenses.
  • No entry is necessary if the original bill is charged directly to the prepaid expense object code.
  • Example:

A department pays a vendor for elevator maintenance for the period from May 1st of this year through April 30th of the following year. Since two months of this period are in the current fiscal year and ten months are in the following fiscal year, a journal should be processed to record 10/12th of the contract cost as a prepaid expense. The entry would debit/charge the balance sheet prepaid expense coding and would credit the appropriate 33-digit expense coding.

The following are general rules regarding Accounts Receivable (A/R):

  • Accounts receivable should be recorded when a tub has not received payment by year-end for income owed to it for goods or services provided by the tub during the current fiscal year. Prior to year-end, the department should determine what income has been earned in the current fiscal year and whether it has been fully collected/received. Any amounts not received by year-end should be recorded as accounts receivable in June. If the amount due is not exactly known, an estimate should be calculated and posted to the General Ledger. Any such amount of $10,000 or more must be recorded.
  • No entry is necessary if the original receipt is credited directly to the accounts receivable object code.
  • Example:

A department provides services to an outside institution in May, but doesn’t receive payment from the customer until July. Because the service was provided in the current fiscal year, an A/R journal for this income should be processed. This entry would debit/charge the balance sheet accounts receivable coding and would credit the appropriate 33-digit income coding. (Note that if billing for this was processed through the Oracle General Accounts Receivable system in June, the receivable would already be properly recorded.)

The following are general rules regarding deferred revenue:

  • Deferred revenue should be recorded when revenue has been received in the current fiscal year but the tub will not be providing the good or service until the next fiscal year. Prior to year-end, the department should determine what income has been received in the current fiscal year where the good or service is not going to be provided until after June 30th. Any such amounts of $10,000 or more must be deferred.
  • No entry is necessary if the original receipt is credited directly to the deferred revenue object code.
  • Example:

A department receives tuition income in May for an executive education course that will be held during the last two weeks of July. Since this income relates to a course that will be held in the following fiscal year, a journal should be recorded to defer this revenue. The entry would debit/charge the appropriate 33-digit income coding and would credit the balance sheet deferred revenue coding.