In accounting, accrual and deferral are two significant terms that define the systematic recording of expenses and revenue in their respective accounting periods. Accurate entry of accruals and deferrals is the key to a sound financial statement and adheres to the complex principles of accounting. This way, the truest financial health of the business is reflected as accruals, and deferrals fall perfectly into their places.
Accrual and deferral pertain to both expenses and revenue that are recorded based on the actual time period they were settled. Accruals are those payables or receivables that are also earned or incurred but not yet received or unpaid to set the demarcation line between the two important terms. On the other hand, deferrals are payables or receivables that are paid in advance. However, the expense is not yet incurred or payments received in advance, even if the revenue has not been delivered yet.
Revenue Accruals and Deferrals Explained
Revenue accrual is the condition when the revenue is earned with the cash out of the equation. Accrued revenue is a form of an asset of the company. The journal entry of this account will be tabulated between a revenue and asset account.
The best example that illustrates the revenue accrual accounting principle is the interest of a bond investment, which was earned in the month of January. Still, the money will be received on a later date, which will fall on the succeeding accounting period. In this case, this will be recorded in an entry that debits Interest Receivable and credits Interest Income.
Revenue Deferral is the accounting principle that pertains to the case of the payment given in advance, even if the revenue is yet to be earned. This is considered as the company’s liability since the revenue has not been earned, but it is already paid in full. The journal entry will fall between a revenue and a liability account.
Take a look at how the insurance policy works. The company receives the money in January, but the coverage of the insurance period will take effect in the next twelve months. The payment should be recorded on the income statement as Revenues to work on its entry.
Expense Accruals and Deferrals Detailed
The expense accrual is the accounting concept of unpaid expenses that have been incurred. They are counted as part of the company’s liability since the payment has not been made yet. The entry is formalized between an expense and a liability account.
A clear illustration of this concept is when you receive your electricity bill for the month of January. You have consumed the service or incurred the expense but have not yet paid it.
Meanwhile, an expense deferral takes place when the cash has been paid in advance, but the expense has not been incurred yet. This accounting entry is clearly an asset to the company. When doing the entry, this will fall between an expense and an asset account.
Expense deferral is the coverage period of your insurance going back to the insurance payment scheme. The ongoing coverage should be recorded to the current asset of the company. Once it expires, it will fall under the expense entry.
Accrual and Deferral Journal Entry Laid Out
When making the adjusting journal entry for accruals and deferrals, they always fall between the income statement and the balance sheet. Particularly, the revenue accrual journal entry is reflected between revenue and asset account, while the revenue deferral accounting entry is placed between revenue and liability account. Meanwhile, the expense accrual journal entry is accounted for between expense, and liability account and the expense deferral journal entry is between expense and liability account.
Deferred or Prepaid Expenses Differentiated
The words ‘deferred’ and ‘prepaid’ are used interchangeably in relation to expenses. However, they should be properly used when referring to the expenses paid in advance as these two terms differ in certain contexts. Deferred expense is used when referring to an expense that has been paid a year or even more in advance and is considered as a long term asset reflected in the balance sheet account. On the other hand, the prepaid expense is when a particular expense has been paid less than a year in advance and is regarded as a current asset in the balance sheet account.