Unit 6:

ACCRUALS AND DEFERRALS

INTRODUCTION TO DEFERRALS & ACCRUALS

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.