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Equipment is a noncurrent or long-term asset account which reports the cost of the equipment. Equipment will be depreciated over its useful life by debiting the income statement account Depreciation Expense and crediting the balance sheet account Accumulated Depreciation (a contra asset account). Insurance Expense, Wages Expense, Advertising Expense, Interest Expense are expenses matched with the period of time in the heading of the income statement. Under the accrual basis of accounting, the matching is NOT based on the date that the expenses are paid. The $500 in Unearned Revenues will be deferred until January through May when it will be moved with a deferral-type adjusting entry from Unearned Revenues to Service Revenues at a rate of $100 per month.
You would record it as a $10,000 debit to cash and a $10,000 deferred revenue credit. An example of expense accrual is an emergency repair required due to a pipe burst. You would hire a plumber to fix the leak but not pay until you received an invoice, say, in a later month. The liability would be documented by deducting $10,000 from costs and crediting $10,000 to accounts payable. Accruals occur after a good or service has been supplied, whereas deferrals occur before a good or service has been delivered.
The deferred expense of XYZ Co. will be reported in its balance sheet until the 12 months pass. The rent expense will also be reported in the company’s income statement only for the months the rent relates to. When the product has already been delivered, i.e. business delivered the product or business consumed the product, but compensation was not received or paid for it, then it is considered as accrual. On the other hand, if a compensation was already received or paid for a product that was not delivered or consumed, then it is considered a deferral. Revenue is recognized in the income statement before it is received in an accrual system.
It is assumed that the decrease in the amount prepaid was the amount being used or expiring during the current accounting period. The balance in Insurance Expense starts with a zero balance each year and increases during the year as the account is debited. The balance at the end of the accounting year in the asset Prepaid Insurance will carry over to the next accounting year. Overall, accrual accounting provides a more accurate and comprehensive view of a company’s financial performance and position. It matches revenue and expenses with the period in which they are earned or incurred, allowing businesses to make informed decisions based on their actual economic activities. Deferral accounting, while simpler to implement, may not capture the economic substance of transactions and can lead to distortions in financial statements.
The matching concept of accounting states that incomes and expenses should be recognized in the period they relate to rather than the period in which a compensation is received or paid for them. This means this concept of accounting requires incomes and expenses to be recognized only when they have been earned or consumed rather than when the business receives or pays cash for them. At the end of the accounting year, the ending balances in the balance sheet accounts (assets and liabilities) will carry forward to the next accounting year. The ending balances in the income statement accounts (revenues and expenses) are closed after the year’s financial statements are prepared and these accounts will start the next accounting period with zero balances.
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The journal entry for accrued expenses establishes a balance sheet liability account. An accrual basis of accounting, as opposed to a cash basis, provides a more realistic picture of a company’s financial situation. A cash basis provides a picture of current cash status but does not reflect future spending and obligations like an accrual technique. According to generally accepted accounting principles (GAAP), firms must record revenue when it is earned and expenses when they are incurred.
Accrued incomes are the incomes of the business that it has already earned but has not yet received compensation for. For example, a business sells products to a customer but the customer has not yet paid for the products and the business has not yet billed the customer. These products can either be physical products such as manufactured goods or can also be the service. Similarly, another example is interest income that a business has rightfully earned but the interest is only credited to the bank account of the businesses semi-annually or annually. Two such concepts that are important in the accounting system of a business are the accruals and deferrals concepts.
Usually financial statements refer to the balance sheet, income statement, statement of cash flows, statement of retained earnings, and statement of stockholders’ equity. Interest Payable is a liability account that reports the amount of interest the company owes as of the balance sheet date. Accountants realize that if a company has a balance in Notes Payable, the company should be reporting some amount in Interest Expense and in Interest Payable. The reason is that each day that the company owes money it is incurring interest expense and an obligation to pay the interest. Unless the interest is paid up to date, the company will always owe some interest to the lender. To assist you in understanding adjusting journal entries, double entry, and debits and credits, each example of an adjusting entry will be illustrated with a T-account.
The purpose of Deferrals is to allow the recording of prepayments of Revenues and Expenses. Deferrals record a liability for cash received before the revenue is earned. Deferrals mean the cash comes before the earning of the revenue or the incurring of the expense. This approach helps highlight how much sales are contributing to long-term growth and profitability. The receipt of payment doesn’t impact when the revenue is earned using this method. When the products are delivered, you would record it by debiting deferred revenue by $10,000 and crediting earned revenue by $10,000.
It represents the amount that has been paid but has not yet expired as of the balance sheet date. This account is a non-operating or “other” expense for the cost of borrowed money or other credit. The income statement, statement of cash flows, statement of retained earnings, and the statement of stockholders’ equity report information for a period of time (or time interval) such as a year, quarter, or month.
Revenues are deferred to a balance sheet liability account until they are earned in a later period. When the revenues are earned they will be moved from the balance sheet account to revenues on the income statement. Under the accrual basis of accounting, revenues are recorded at the time of delivering the service or the merchandise, even if cash is not received at the time of delivery. One of the main financial statements (along with the balance sheet, the statement of cash flows, and the statement of stockholders’ equity). The income statement is also referred to as the profit and loss statement, P&L, statement of income, and the statement of operations. The income statement reports the revenues, gains, expenses, losses, net income and other totals for the period of time shown in accrual and deferral the heading of the statement.
