Accrual accounting utilizes both expense and revenues of a company to denote its financial position. These accounting records are what occurred either as revenues or as expenses and therefore must be shown in a company’s income statement and balance sheet. Accrual accounting brings forward a transaction so that it can be recognized during the current events instead of being delayed for later.
Its example can include; utility bills, rent paid in advance, interest, purchase on credit, etc.
The first type is the expense accrual, which refers to reporting a transaction that occurred as an expense and the liability that it occurred against. It is reported before the period of time when the expense has to be paid or when the invoice has to be processed.
In expense accrual, when the journal entry is to be reported, it’s made as an accrual adjusting entry where the bill charged is debited, whereas a liability account is credited termed as Accrued Expenses Payable.
In business settings, accountants may use the term in a statement such as, “The interest on the bank loan needs to be accrued.” This refers to how the interest was accrued but not recorded yet and since the interest ultimately has to be paid at the end of the accounting period. Therefore, an accrual adjusting entry is made for such a transaction.
Another example of this can be considered such that utility bills have to be paid at the end of the month even though the electricity, gas, or water services are used before the bill is paid. Incurring an accrual expense on the company that it will bill and receive money for at the end of the accounting period.
In order to record this, an accrual adjusting journal entry will be made that will denote the correct amount of expense that has been accrued so that the company can report these in its income statement and balance sheet accordingly.
The second type is the revenue accrual which refers to the reporting of a transaction that occurred as revenue and the asset that it occurred against. These revenues are reported during the period they were earned, which means this is before the money was received or the invoice was processed.
The journal entry for this is reported as an adjusting entry where the debit would include the revenue earned, and the credit would be the income it was earned off of.
In business settings, accountants may use the term in a statement such as, “The interest earned off of the loan given has to be accrued.” This refers to the interest that the company earned through the loan given. The interest may not have been received as the accounting period completes sometime in the future.
Therefore, an accrual type adjusting entry is made for the revenues earned as per the services provided, even though they will be billed at the end of their accounting period.
The transaction would be recorded to prove that such an agreement took place and that the company has an obligation to receive the interest it earned and can be reported as an asset on its financial statements.
Deferral accounting is contrary to accrual accounting, where entries are made in the resent even though the bills that occurred have to be divided into two or more accounting periods, as adjusting entries for both expenses and revenues have to be reported into the company’s financial statements.
Therefore, in deferral accounting, the account is where the income is recognized at a future date.
Its example can include; annuity, charges, taxes, income, etc.
The first type of deferral is expense deferral. An expense deferral is one where a payment was made before the accounting period, therefore, becoming an expense that is to be reported in the financial statements. The paid-out money should be reported at a later date, but that the money was received before it could be reported.
Let’s assume a company made a payment for their insurance which covers them for 6 months into the future. The amount that was made will be added to the current assets recorded as Prepaid Insurance or Prepaid Expenses. However, the amount that expires within the accounting period would be reported as an Insurance Expense.
In business practices, accountants may use the term in statements such as, “Our insurance expense needs to be deferred,” this means that the company would have paid in advance for the next 6 months even though during the current month, only one month of insurance would be utilized.
Therefore, the next 5 months are deferred on the company’s financial statements as Prepaid Insurance until they can be moved to Insurance Expenses after the 5 months have elapsed.
Another example of this could be that when a company purchases supplies, it defers the cost of those supplies since not all the supplies bought were used or consumed during the accounting period it was reported under. Therefore, an adjusting entry would be necessary to defer the cost of the supplies that the company did not utilize.
The second type of deferral is called the Revenue Deferral, which refers to money that was received before it was earned. Thereby becoming a source of revenue for the company that is to be reported in the financial statements. It is the revenue that the company has already received before its services for the money earned was executed.
Let’s assume that an insurance company is on the receiving end of the customer and is being paid in advance for its insurance. It will provide the customer with insurance for the next 6 months, but these services are not yet completed. Still, the customer would have to pay for this insurance upfront.
In the company’s financial statements, this would be reported under unearned amount, which will be a liability until the company provides these services and earns money. As the services are provided, these transactions will move to the income statement, where they will be reported as Insurance Revenues.
Another example of this in business settings can be that if a company receives $100 in exchange for providing high-speed internet services, for the next month, this amount would be listed under deferred payment recorded as a liability until the business provides the internet service for the next month and earns its payment. Once earned, they will be moved from Unearned Revenues to Service Revenues.
Difference between Accrual and Deferral Accounting:
Knowing the difference between these two adjusting entries is integral for every accountant who wants to make sure that their books remain up to date and concrete in terms of the accounts they handle.
These two types of adjusting entries serve the same function but in contrast to one another. The main glaring difference being that accrual is used to bring a transaction forward into the current time period whereas, a deferral delays that recognition into a future time period. These transactions are also noted differently as journal entries.
They can both be used for expenses or revenues based on the nature of the transaction. These adjusting entries ensure that a fair valuation is given to the customer or the business with whom the transaction was conducted. It makes sure that both parties of the agreement have recorded their accounts accordingly so that no discrepancy is left unwarranted.