Accruals

- conditions are satisfied to record a revenue or expense, but money has not changed hands yet. Examples: Accounts Receivable - work done or goods sold but the customer has not yet paid us Accounts Payable - expenses incurred but we have not yet paid the supplier These are recorded before financial statements are prepared, so the statements reflect all revenue earned, and expenses incurred.

Example Accrued Expense (accounts payable) ComputerRx installs computer networks. They often hire an independent contractor to run cables for the network. They are billed twice a month at a rate of $1.50 per foot of installed cable, including parts and labor. At the end of the month they estimate the contractor installed 500 feet of cable that they had not been billed for. The company should record an accounts payable for $750 ($1.50 x 500 ft). General Journal Date Mar-31 Account Installation Expense Accounts Payable To accrue installation expense at end of month. The following month when the company pays the installer, they will record the payment, as follows. Debit $750 $750 Credit

Date Apr-10

Account Accounts Payable Cash To record payment on account.

Debit $750

Credit $750

Note, in both examples above, the revenue or expense is recorded only once, and in the correct month. The second journal entry reflects the receipt or payment of cash to clear the account receivable or payable.

Deferrals

- money has changed hands, but conditions are not yet satisfied to record a revenue or expense. Prepaid Expenses - insurance, rent, advertising paid in advance but the expense shows up on future income statements. Unearned Revenue - subscriptions, maintenance contracts paid in advance but the revenue shows up on future income statements. These are recorded before financial statements are prepared, so the statements reflect all revenue earned, and expenses incurred. Let's look at a time line and see how it works. Deferrals are often referred to as allocations. Costs are spread over a number of months using a reasonable method of allocation. In the example below, we use the straight line method - an equal amount is allocated to each month. Other reasonable methods can be used as well.

Example

Deferred

Expense

The company has an option of paying its insurance policy once per year, twice a year (2 installments) or monthly (12 installments). They decide to pay it twice a year, in January and July. To get a proper matching of expense to the period we spread each 6-month payment equally over the period the insurance policy covers. The effect of this is to 1) match the appropriate expense with the month it relates to, and 2) eliminate

Month> $ spent> Expense taken

Jan $600 $100

Feb $0 $100

Mar $0 $100

Apr $0 $100

May $0 $100

Jun $0 $100

total $600 $600

Money is spent only once each 6 months, but the expense is allocated to each month by enter an adjusting journal entry in the books. Here's how the first journal entry would look. General Journal Date Jan-2 Account Prepaid Insurance Cash To record payment of 6 months insurance policy And the entry to record January insurance expense at the end of the month. Debit $600 $600 Credit

Date Jan-31

Account Insurance Expense Prepaid Insurance

Debit $100

Credit $100

To record one month insurance policy And finally, the Ledger accounts. General Ledger Prepaid Insurance Date Jan-2 Jan-31 Description Debit $600 $100 Credit Balance $600 $500

Prepaid Insurance declines each month as the expense is transferred from the Balance Sheet to the Income Statement. Insurance Expense Date Jan-31 Description Debit $100 Credit Balance $100