Accounting: The Language of Business - Vol. 2 (Intermediate: Part 31)

Professional accountants should use that influence to encourage the companies they serve to think long term and integrate sustainable development goals into their accounting, such as by including a natural capital account, which I have heard is gaining ground.

Kofi Annan

Review of the Accounting Cycle (Part H)

by

Charles Lamson

 Accruals

Accruals occur when the economic event that gives rise to revenue or expenses occurs before the cash is received or paid. The two types of accruals are accrued revenues and accrued expenses.

Accrued Revenues. Accrued revenues occur when control of the good or service has passed to the customer but the seller has not yet received cash. For example, a wholesaler may deliver goods to a retailer on credit. In this case, there is an unrecorded asset (a receivable) and unrecognized revenue. So, both assets and revenues are understated until the company makes an adjusting journal entry. Exhibit 4.12 presents this asset-revenue relationship. 

EXHIBIT 4.12 Accrued Revenues

If the company does not adjust accrued revenue, then assets and revenues are both understated. The adjusting journal entry is needed to debit the asset account and credit the revenue account. Once the cash is received, the company debits cash and credits the asset (receivable) account.

EXAMPLE 4.8 Accrued Revenues

PROBLEM: On December 31, Plush Service Corporation received an invoice from a field technician indicating that service amounting to $35,000 had been provided but not yet billed to customers.

 What adjusting journal entry is needed as of the end of the accounting period? Prepare the t-accounts for accounts receivable and service revenue earned both before and after the adjusting journal entry.

SOLUTION: Without the adjusting journal entry, Plush's assets and revenues are both understated. Currently, Plush has not prepared any journal entries related to this transaction.

On December 31, an adjusting journal entry is required that will debit accounts receivable and credit service revenue.

Thus, at the end of the accounting period, the adjusted balances in these accounts are correct.

Accrued Expenses. Accrued expenses occur when a company has incurred expenses but has not paid cash. For example, companies may incur an utility expense before a bill is received at the end of the month, and that amount remains unpaid at the end of the accounting period. Other common examples of accrued expenses are salaries and interest. In these cases, there is an unrecorded liability (a payable) and an unrecognized expense. The company understates both liabilities and expenses until it makes the adjusting journal entry. Exhibit 4.13 presents this liability expense relationship.

EXHIBIT 4.13 Accrued Expenses

The adjusting journal entry debits the expense account and credits a liability account. Once cash is paid, the company debits the liability (payable) and credits cash.

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Example 4.9 Accrued Expenses

PROBLEM: Plush Service Corporation incurs salaries of $4,000 at the end of the year. The next payroll date is January 2 of the following year.

What adjusting journal entry is needed as of the end of the accounting period on December 31? Prepare the t-accounts for salaries payable and salaries expense both before and after the adjusting journal entry.

SOLUTION: Without the adjusting journal entry, Plush's liabilities and expenses are both understated. Currently, Plush has not prepared any journal entries related to this transaction.

On December 31 an adjusting journal entry is required that will debit salaries expense and credit salaries payable.

Thus, at the end of the accounting period, the adjusted balances in these accounts are correct.

Exhibit 4.14 summarizes the different types of adjusting journal entries.

EXHIBIT 4.14 Summary of Adjusting Journal Entries 

*GORDON, RAEDY, SANNELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 110-113*

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