ACCT1110 Chap.3 Accrual Accounting
Accrual Accounting
Accrual accounting recognises income when it is earned and expenses when they are incurred, whatever the bank is doing. The cash basis does the reverse and is simpler, but it hands management a lever: delay a payment or bring a receipt forward and reported performance moves.
Every adjustment in this topic exists to close that gap at balance date, which is why the in-semester exam concentrates here.
There are only four shapes an adjustment can take, and naming the shape decides both accounts before any figure is written. Two are deferrals, where cash moved first: a prepaid expense, where you paid before consuming, and revenue received in advance, where you were paid before delivering.
Two are accruals, where the event happened first: an accrued expense, incurred but unpaid, and accrued revenue, earned but uninvoiced. Every one of the four touches one income statement account and one balance sheet account, and none of them touches cash. An adjusting entry with cash in it is not an adjusting entry.
Revenue received in advance is the idea most often misread.
Money in the bank for something not yet delivered is an obligation, so the receipt creates a liability and income is recognised in instalments as the obligation is discharged. A club selling a full season of tickets in one month recognises that income across the matches actually played, not in the month of the sale.
What this chapter covers
- 01
Recognition against receipt
- 02
How the cash basis moves reported performance
- 03
Prepaid expenses and revenue received in advance
- 04
Accrued expenses and accrued revenue
- 05
The one income statement account, one balance sheet account rule
- 06
Releasing a liability in proportion to delivery
- 07
Interest accrued at balance date
- 08
What an omitted adjustment does to the statements
Four adjustments at one balance date, one from each branch
- +1Insurance: cash moved first, so this is a deferral. Three of twelve months are consumed, giving $28,800 times 3/12 = $7,200. Debit insurance expense and credit prepaid insurance; $21,600 remains an asset.
- +1Bookings: cash moved first again, and part of the obligation is discharged. Debit bookings received in advance $17,500 and credit function revenue $17,500, leaving a liability of $28,500.
- +1Cleaning: the service came first, so this is an accrued expense. Debit cleaning expense $5,340 and credit accrued expenses payable $5,340.
- +1Corporate rooms: the service came first on the income side. Debit accounts receivable $12,900 and credit accommodation revenue $12,900.
Key terms
- Deferral
- An adjustment needed because cash moved before the service, covering prepaid expenses on the payment side and revenue received in advance on the receipt side.
- Accrual
- An adjustment needed because the service came before the cash, covering expenses incurred but unpaid and income earned but uninvoiced.
- Prepaid expense
- An asset created by paying before consuming, released to expense over the periods that use it up rather than in the month the payment left.
- Accrued expense
- An obligation for something already received and not yet paid for. Omitting it understates both expenses and liabilities by the same amount.
- Adjusting entry
- A period end entry pairing one income statement account with one balance sheet account. It never involves cash, which makes that a reliable test of your own work.
- Matching
- Recognising an expense in the period whose income it helped produce, which is the reasoning behind every deferral and every accrual in this topic.
Accrual Accounting FAQ
Why is money received in advance treated as a liability?
Because the entity owes something: either the performance promised or a refund. Until the goods or service are supplied, the receipt is not income. It becomes income in instalments, in proportion to how much of the obligation has been discharged. A twelve month membership sold on 1 January is recognised one twelfth at a time; eleven home matches sold as a season are recognised match by match.
How do I know how much of a deferred amount to release?
Read what the customer was promised and count how much has been supplied. If the promise is measured in months, release by months. If it is measured in matches, lessons or deliveries, release by those. Questions in this area deliberately give both a number of months and a number of events, and the one the promise was written in is the one you use.
What happens if an accrual is left out?
The expense is missing, so profit is overstated, and the obligation is missing, so liabilities are understated. Equity is overstated by the same amount as profit, which keeps the accounting equation balanced while two reported figures are wrong. That is precisely why a balanced set of records is not evidence that the records are complete.
Can an adjusting entry ever include cash?
No, and that makes it a useful self check. Adjusting entries redistribute amounts between periods; the cash movement they relate to happened earlier or will happen later. If you have written cash into an adjustment, you have most likely recorded the original transaction a second time rather than adjusted it.
Exam move
Practise classifying before you practise journalising. Write out twenty short scenarios, and for each one answer a single question in writing: did the cash move before or after the service. Only then write the entry.
Students who go straight to the entry get the accounts right roughly half the time; students who classify first rarely miss.
Then rehearse the release calculations until the fractions are automatic, because this is where the multiple choice paper sets its traps.
Three of twenty-four months, two of eleven matches and four of twelve weeks all look similar under time pressure, and the difference between them is the whole question.
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