Accrual
Entries are special journal entries recorded in the books at the end of each
accounting period and before financial statements are prepared and issued. Accruals
are part of the Matching Principle method where revenues and expenses are
recorded when they are incurred, regardless of when cash is exchanged.
There are two types of accruals.
1. Accrued
Revenue
2. Accrued Expense
Accrued
Revenues are revenues that have been earned but are not
yet recorded in the books of accounts at the end of each accounting period. Accountants
recognize revenues as earned, whether or not the company has received cash.
Goods or services have been delivered to the client but there
was no billing yet. Thus, even though a company doesn’t have an Invoice yet for
services or goods delivered, the revenues must be recorded in the books
accounts.
Example:
Company ABC entered into a one year lease contract for its two brand new
heavy equipments to a client for $144,000.
Contract starts Jan 15, 2013 and ends on Jan 14, 2014.
Contract states that billing is every 30 days and payment term is 30
days from date of Invoice.
Company ABC’s accounting period is monthly.
Adjusting Journal Entry:
Jan 31, 2013 Dr. Unbilled Receivable
$6,800
Cr. Rental
Revenue $6,800
To record accrued revenue for 17 days (Jan 17-31, 2013) for the lease of
two brand new heavy equipments
Reversing Journal Entry:
Feb 1, 2013 Dr. Rental Revenue $6,800
Cr. Unbilled
Receivable $ $6,800
To reverse the accrual entry made in January for the lease of two heavy
equipments.
Actual Billing Entry:
Feb 15, 2013 Dr. Account
Receivable $12,000
Cr. Rental
Revenues $12,000
30 days billing from January 15 to February 13,
2013 for two heavy equipments
From January 15-31, Company ABC already earned 17 days of the 30 day
billing period. It must recognize and record that 17 days for January by
passing an accrual entry on January 31.
On the first day of the next accounting period, the accrual entry was
reversed. Reversing entries are used to simplify the entry on the next period.
When the Invoice was cut on Feb 15, 2013, the accountant simply debits (Dr.)
Accounts Receivable and credit (Cr.) to Revenues the Invoice amount. The accountant doesn’t need to worry about the
number of days that pertains to January and February because the accrual and
reversing entry takes care of it.
Rental
Revenues account- 17 days rent for January and 13 days rent for
February must be recognized at the correct accounting period. We achieved that because
of the accrual entry, reversing entry and actual billing entry we posted in
January and February.
Unbilled
Receivable account – normally this account has zero balance once the
reversing entry is posted. The February balance of Unbilled Receivable ($6,800-$6,800)
is $0 because of the reversal entry knocking off the balance created on the
accrual entry.
Accounts
Receivable account - When the actual billing was made in February, it resulted
to $12,000 accounts receivable. This amount is the correct Invoice value collectible
to the client.
Accrued Expenses are expenses that have been incurred but are not yet recorded in
the books of accounts at the end of each accounting period. Accountants
recognize expenses as incurred, whether or not the company has paid out cash.
Goods or services have been received from the supplier but the
billing did not arrived yet. Thus, even though a company doesn’t have the Invoice
yet from the supplier for services or goods received, the expenses must be recorded
in the books of accounts. In the case of non-suppliers, expenses incurred already
but not yet paid.
Example 1:
Company ABC payroll cut-off is every end of the month. Payment is every 2nd
day of the succeeding month. Payroll for the month of January 2013 is $12,000.
Adjusting Journal Entry:
Jan 31, 2013 Dr. Salaries Expense $12,000
Cr. Accrued
Salaries $12,000
To record accrued salaries for the month of January 2013.
Reversing Journal Entry:
Feb 1, 2013 Dr. Accrued Salaries $12,000
Cr. Salaries
Expense $12,000
To reverse the accrual entry made for January 2013 salaries.
Actual Payment Entry:
Feb 2, 2013 Dr. Salaries Expense $12,000
Cr. Cash $12,000
To record payment of January 2013 salaries .
Salaries
Expense - Under the accrual base accounting, expenses must be
recorded on the accounting period they were incurred. Thus, we made an accrual
entry in January 31 to record the salaries expense.
We have two transactions in February, reversing entry and
actual payment of salary entry. These two entries resulted in a net transaction
balance of $0.
Accrued Salaries- normally
this account has zero balance once the reversing entry is posted. The February
balance of Accrued Salaries ($12,000-$12,000) is $0 because of the reversal
entry knocking off the balance created on the accrual entry.
Example 2:
Company ABC entered into a one year lease contract for one brand new car
from Rent-A-Car.
Lease amount is $14,400.
Contract starts Jan 15, 2013 and ends on Jan 14, 2014.
Contract states that billing is every 30 days and payment term is 30
days from date of Invoice.
Company ABC’s accounting period is monthly.
Adjusting Journal Entry:
Jan 31, 2013 Dr. Rent Expense $680
Cr. Accrued
Rent Payable $680
To record accrued rent expense for 17 days (Jan 17-31, 2013) for the
lease of one car
Reversing Journal Entry:
Feb 1, 2013 Dr. Accrued Rent
Payable $680
Cr. Rent
Expense $$680
To reverse the accrual entry made in January 2013
for the lease of one car
Entry Upon Receipt of Invoice from Rent-A-Car:
Feb 15, 2013 Dr. Rent Expense $1,200
Cr. Rent
Payable $1,200
To record 30 days rent for one car from January
15 to February 13, 2013
Rent
Expense - 17 days rent for January and 13 days rent for February
must be recognized at the correct accounting period. We achieved that because of
the accrual entry, reversing entry and actual billing entry we posted in
January and February.
Accrued
Rent Payable – normally this account has zero balance once
the reversing entry is posted. The February balance of Accrued Rent Payable ($680-$680)
is $0 because of the reversal entry knocking off the balance created on the
accrual entry.
Rent
Payable - When the actual billing was received from the lessor, the
Invoice amount was recorded. This amount is the correct Invoice value and
payable to Rent-A-Car.
Accounting
softwares
Accounting softwares makes recording of reversing entries
easier.
The program can automatically reverse all accrual entries on
the first day of the next accounting period. This program saves you time and
effort.
Reversing Entries
Reversing entries are an option. They
are not required. If you do not want to make a reversal entry, you need to take
a look at the accrual entry you’ve made and then do the necessary compound
entry later on. It removes the duplication of revenues and eliminates the need
of a compound entry. It allows an efficient processing and recording of the transactions.
No Reversing Entries
If you prefer not to use reversing entries, that is perfectly
permitted. What is really important is that the revenues and expenses are
recorded at the correct accounting period.
In the Accrued Revenue example, if there is no reversing
entry, actual billing will be recorded as follows:
Actual Billing Entry:
Feb 15, 2013 Dr. Account
Receivable $12,000
Cr. Rental
Revenues $5,200
Cr.
Unbilled Receivable $6,800
30 days billing from January 15 to February 13,
2013 for two heavy equipments.
The effect on the balances of Rental Revenues, Unbilled
Receivables and Accounts Receivable is just the same.
However, the accountant needs to check the accrual entry
posted before in order to come up with the correct compound entry.
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