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o Understand Accrual and Deferrals

o Accrued Expense

o Accrued Revenue

o Deferred Expense

o Deferred Revenue

Chapter 17 Accounting for Accruals and

Deferrals

Accruals and Deferrals

• Accruals

Expenses incurred and revenue earned in the

current accounting period but not recorded as of

the end of the period

Accrual Basis

Applies the matching principles of accounting

Record revenue in the period earned

(regardless of when cash changes hands)

Record expenses in the same period that

generated the revenue

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• Deferrals

Expenses and revenue that have been recorded in

the current accounting period but are not incurred

or earned until a future period

Accrued Expenses• Expenses that build up or accumulate during the current period but will

not be paid until the next period; AKA accrued liabilities

• Recorded in the current period

Debit to an expense account

Credit to a liability account

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Assume that Bluff City Supply Company pays its employees every Friday

for a normal five-day workweek and that the weekly payroll is $20,000.

Dec. 31, 20X1, is a Wednesday. The week’s salaries will be paid on Friday,

Jan. 2, 20X2. Daily salaries are $20,000 ÷ 5 days = $4,000. Employees

are owed for Monday, Tuesday and Wednesday, the last 3 days of the

accounting period. The following entry is prepared on Dec. 31, 20X1:

20X1

Dec.31 Salaries Expense 12,000

Salaries Payable 12,000

Paying Accrued Salaries Expense-No Reversing

Entry

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• Assume that Bluff City Supply Company pays its employees every

Friday for a normal five-day workweek and that the weekly payroll is

$20,000. Dec. 31, 20X1, is a Wednesday. The following entry was

prepared on Dec. 31, 20X1:

20X1

Dec.31 Salaries Expense 12,000

Salaries Payable 12,000

• On Friday, Jan. 2, 20X2, Bluff City paid the payroll for the week and

prepared the following journal entry:

20X2

Jan.2 Salaries Expense 8,000

Salaries Payable 12,000

Cash 20,000

Paying Accrued Salaries Expense-Reversing Entry Used

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• Assume that Bluff City Supply Company pays its employees every

Friday for a normal five-day workweek and that the weekly payroll is

$20,000. Dec. 31, 20X1, is a Wednesday. The following entry was

prepared on Dec. 31, 20X1:

20X1

Dec.31 Salaries Expense 12,000

Salaries Payable 12,000

• On Thursday, Jan. 1, 20X2, Bluff City made the following reversing

entry (an exact opposite of the adjusting entry):

20X2

Jan.1 Salaries Payable 12,000

Salaries Expense 12,000

• On Jan. 2, 20X2, makes the following entry to payment of salaries:

20X2

Jan.2 Salaries Expense 20,000

Cash 20,000

Adjusting for Accrued Interest Expense

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• Assume that on Nov. 1, 20X1, Bluff City Supply Company borrowed

$12,000 on a 90-day, 14% note.

• The due date of the note is Jan. 30, 20X2.

• An adjusting entry must be made on Dec. 31, 20X1, to record the

accrued interest.

• The accrued interest is calculated for the period of Nov. 1 to Dec. 31,

20X1.

• Interest = $12,000 × .14 × 60 days ÷ 360 days = $280

• The following adjusting entry is prepared:

20X1

Dec.31 Interest Expense 280

Interest Payable 280

Paying Accrued Interest Expense-No Reversing Entry

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• On Jan. 30, 20X2, Bluff City Supply Company must repay the note and

the total amount of interest.

• We need to compute the interest for the current period; the 30 days in

January.

• Interest = $12,000 × .14 × 30 days ÷ 360 days = $140

• The following entry is prepared on January 30, 20X2, to repay the note

and the total amount of interest:

20X2

Jan.30 Notes Payable 12,000

Interest Expense 140

Interest Payable 280

Cash 12,420

Paying Accrued Interest Expense-Reversing Entry

Used

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• Assume on Jan. 1, 20X2, Bluff City made the following reversing entry:

20X2

Jan.1 Interest Payable 280

Interest Expense 280

• On Jan. 2, 20X2, makes the following entry to pay the note and

total amount of interest:

20X2

Jan.2 Notes Payable 12,000

Interest Expense 420

Cash 12,420

Accrued Revenue

• Revenue that has been earned but will not be received until the next

accounting period. Must be recorded in the current period to properly

match revenue and expenses.

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• Assume that on Nov. 1, 20X1, Burroughs Company entered into a three-

month lease agreement with White Company. Terms of the lease require

that full payment of $1,800 for all three months be made by White on Jan.

31, 2X02. On Dec. 31, 20X1, Burroughs will have earned two months of

interest (November and December). An adjusting entry must be prepared

for the accrued revenue as of Dec.31, 20X1.• $1,800 ÷ 3 months = $600/month; $600/month × 2 months = $1,200

20X2

Dec.31 Rent Receivable 1,200

Rent Income 1,200

Recording the Receipts of Accrued Revenue-No

Reversing Entry

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• On Jan. 31, 20X2, Burroughs will receive the full $1,800 due from White.

• Burroughs must record the receipt of $1,800, record one month’s rent

income earned in 20X2, and remove the receivable from the books.

• The following entry is prepared on Jan. 31, 20X2, to record the cash

receipt and the current period’s revenue:

20X2

Jan.31 Cash 1,800

Rent Receivable 1,200

Rent Income 600

Recording the Receipts of Accrued Revenue-Reversing Entry Used

• Assume that on Nov. 1, 20X1, Burroughs Company entered into a three-month

lease agreement with White Company.

• Terms of the lease require that full payment of $1,800 for all three months be

made by White on Jan. 31, 2X02.

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• On Dec. 31, 20X1, Burroughs recorded the following adjusting entry for 2

months of accrued interest:

20X1

Dec.31 Rent Receivable 1,200

Rent Income 1,200

• Assume on Jan. 1, 20X2, Burroughs made the following reversing entry:

20X2

Jan.1 Rent Income 1,200

Rent Receivable 1,200• On Jan. 31, 20X2, makes the following entry to record receipt of the total amount of rent:

20X2

Jan.31 Cash 1,800

Rent Income 1,800

Summary of Accruals

• An accrual always adds to the expense or the revenue.

• The adjusting entry for an accrual always creates a balance sheet

account-either a payable or a receivable.

• An accrual adjustment can always be reversed.

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Deferred Expenses

• An advance payment for goods or services that benefit more than

one accounting period

• The prepayment can be initially recorded in two different ways:

As an asset

As an expense

• The end-of-period adjustment depends on the way in which the

deferred expense was initially recorded.

• Both methods result in the same amount of expense being allocated

to the two accounting periods involved.

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Deferred Expenses Recorded as Assets

On Oct. 1, 20X1, Bluff City Supply Company purchased casualty

and theft insurance for a period of one year at a cost of $3,600.

Bluff prepared the following entry to record the purchase of the

insurance:20X1

Oct.1 Prepaid Insurance 3,600

Cash 3,600

• The amount of insurance that expires each month is $3,600 ÷ 12

months = $300. On Dec. 31, 20X1, Bluff records the following entry

to transfer 3 months of insurance (Oct. to Dec.) from the asset

account to an expense account:

20X1

Dec.

3

1Insurance Expense 900

Prepaid Insurance 900

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Deferred Expenses Recorded as Expenses• On October 1, 20X1, Bluff City Supply Company purchased casualty

and theft insurance for a period of one year at a cost of $3,600.

• Bluff prepared the following entry to record the purchase of the

insurance:

20X1

Oct.1 Insurance Expense 3,600

Cash 3,600

20X1

Dec.

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1Prepaid Insurance 2,700

Insurance Expense 2,700

Reversing Entries for Deferred Expenses Recorded Initially

as Expenses• If the initial entry for a deferred expense was recorded as an expense,

the adjusting entry will create an asset. The fact that this asset account

was created as part of the adjusting process allows you to reverse the

adjustment.

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On Dec. 31, 20X1, Bluff records the following entry to transfer 9

months of insurance (Jan. to Sep. of 20X2) from the expense account

to the asset account:

20X1

Dec.

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1Prepaid Insurance 2,700

Insurance Expense 2,700

The following entry is prepared on January 1, 20X2, to reverse the

adjustment:20X2

Jan.1 Insurance Expense 2,700

Prepaid Insurance 2,700

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Deferred Revenue

• Revenue that has been received in the current period but will

not be fully earned until the future.

• Must be pushed off to future periods to match revenue and

expenses properly.

• Can be initially recorded in two different ways

As a liability

As revenue

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• The end-of-period adjustment depends on the way in which the

deferred revenue was initially recorded.

• Both methods result in the same amount of revenue being

allocated to the two accounting periods involved.

Deferred Revenue

How would the New York

Yankees organization record

money collected in advance

from season ticket sales?

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• Money collected in advance is unearned revenue because no

goods or services have been delivered or provided.

• Unearned revenue is a liability, and is recognized as revenue

only as the goods or services are provided.

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Deferred Revenue Recorded as a Liability• On Apr. 1, 20X1, Laurel Publishers receives in advance annual subscriptions

that total $120,000. Laurel records the cash receipt as a liability and records

the following entry:

20X1

Apr. 1 Cash 120,000

Unearned Subscriptions Income 120,000

The Unearned Subscriptions Income account is a liability account with a

normal credit balance. Per month Laurel earns $120,000 ÷ 12 months =

$10,000.

On Dec. 31, 20X1, Laurel records the following entry to transfer 9

months of subscriptions received (Apr. to Dec.) from the liability account

to a revenue account:

20X1

Dec. 31 Unearned Subscriptions Income 90,000

Subscriptions Income 90,000

Deferred Revenue Recorded as Revenue

• On Apr. 1, 20X1, Laurel Publishers receives in advance annual

subscriptions that total $120,000. Laurel records the cash receipt as

revenue and records the following entry:

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•20X1

•Apr. •1 •Cash •120,000

•Subscriptions Income •120,000

Per month, Laurel earns $120,000 ÷ 12 months = $10,000.

On Dec. 31, 20X1, Laurel records the following entry to transfer 3

months of subscriptions not yet earned (Jan. to Mar. of 20X2) from the

revenue account to a liability account:

20X1

Dec. 31 Subscriptions Income 30,000

Unearned Subscriptions Income 30,000

Reversing Entries for Deferred Revenue Recorded Initially

as Revenue• If the initial entry for deferred revenue was recorded as revenue, the adjusting entry will

create a liability.

• The fact that this liability account was created as part of the adjusting process allows you to

reverse the adjustment.

• Laurel recorded the following entry to receive $120,000 of subscriptions on April 1, 20X1:

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20X1

Apr. 1 Cash 120,000

Subscriptions Income 120,000

Laurel prepared the following adjusting entry on Dec. 31, 20X1:

20X1

Dec. 31 Subscriptions Income 30,000

Unearned Subscriptions Income 30,000

The following entry is prepared on January 1, 20X2, to reverse the adjustment:

20X2

Jan. 1 Unearned Subscriptions Income 30,000

Subscriptions Income 30,000

Summary of Reversing Entries

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ReverseDo Not

Reverse

All accruals

Deferred expenses initially recorded

as expenses

Deferred revenue initially recorded

as revenue

Deferred expenses initially recorded

as assets

Deferred revenue initially recorded

as a liability

Comparison of Methods for Recording Deferred RevenueReceived advance subscriptions of $120,000 for 12 issues of a magazine.

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Comparison of Methods for Recording Deferred RevenueReceived advance subscriptions of $120,000 for 12 issues of a magazine.

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Joining the Pieces

Accruals and

Deferrals