Accruals and Deferrals

8/6/2019 Accruals and Deferrals

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Accruals and Deferrals:Accruals and Deferrals:Timing is Everything in AccountingTiming is Everything in Accounting


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JOIN KHALID AZIZJOIN KHALID AZIZ

ECONOMICSOFICMAP, ICAP, MA-ECONOMICS, B.COM.

FINANCIAL ACCOUNTINGOFICMAP STAGE 1,3,4 ICAPMODULE B, B.COM, BBA, MBA & PIPFA.

COST ACCOUNTINGOFICMAP STAGE 2,3 ICAP MODULED, BBA, MBA & PIPFA.

CONTACT:

0322-3385752

0312-2302870

0300-2540827

R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,

KARACHI, PAKISTAN.


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FRESH CLASSES

ICAP MODULE B & D

FINANCIAL ACCOUNTING,BUSINESS ECONOMICS & COST

ACCOUNTING.

INDIVIDUAL & GROUPS


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FRESH CLASSES OF MAECONOMICS

EXTERNAL.GUESS PAPERS AND

PAST PAPERS OF1998-2009 ARE AVAILABLE.


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More About AccrualsMore About Accruals

Accrual Accounting: Recording thefinancial transactions of a business

in the period in which they occur,

rather than in the period in whichcash is exchanged.

The economic substance of the

transaction signals therecordingnot disbursing or

receiving cash.


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Examples of Accrual EventsExamples of Accrual Events

Sales made on account

Purchases made on credit

Wages expense for employees

when theyve worked but you havent yet paid

them

Interest on money borrowed or lent

when time has passed (so interest has been

earned by the lender) but the actual cash for the

interest has not changed hands

Income tax expense

when you owe it but havent yet paid the IRS


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Accounts Receivable:Accounts Receivable:

Amounts owed by customersAmounts owed by customers

for goods and services receivedfor goods and services received

RecognitionRecognition of eventof event versus realization ofrealization of

cashcash

recognizing a revenue or expense means torecord it in the accounting records so that it

shows up on the income statement

WhenWhen is revenue recognized?

when the amounts are earned (requiredactivities are complete)

Realization means you actually get the cash.


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Accounts Payable:Accounts Payable:

Amounts you owe creditorsAmounts you owe creditors

for the purchase of goods and servicesfor the purchase of goods and services

When are costs

recognized as

expenses? when the matching

revenue is

recognized, or

when the benefits ofthe expenditures are

received

INVOICE


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AccrualsAccruals that need to be made before thethat need to be made before thefinancial statements are preparedfinancial statements are prepared ----

adjustments to the booksadjustments to the books

1. Any revenue earned that has not been billed(no receivable has been recorded)

2. Any interest revenue that has been earnedon investments that has not been recorded

3. Any expense that has been incurred (used)but has not been recorded (a common one

is salary expense)4. Income tax expense incurred but not

recorded


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RevenueRevenue that needs to be accruedthat needs to be accrued

Work that has been

completed -- but nothing

has been recorded for

the financial statements. This situation arises when

a customer has not been

billed yet has not paid

Computerization of record-

keeping has made this

situation less frequent


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Example:Example:

1.1. Revenue to be accruedRevenue to be accrued

An employee of Maids-R-Usfinished cleaning a house

on January 31, but didnt get

the paperwork into the office

in time to get it included inthe January records.

An income statement for

January must include therevenue because it has

been earned.


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Accruing RevenueAccruing Revenue

Accruing revenue affects the accounting

equation in the following way:

Assets = Liab. + Cont. Cap. + Retained Earnings

+ A/R + Revenue

Income Statement:

Statement of Changes in Equity:

Statement of Cash Flows:

Increases income

Increases equity

No effect on cash flows


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What happens when the customer pays?What happens when the customer pays?

When the customer pays,

the accounting equation

is affected on the asset

side only. A/R is decreased by the

amount of the payment

Cash is increased by the

amount of the payment

The revenue has already

been recognized.


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Interest RevenueInterest Revenue

You have a 6-month, Rs.100 CD that earns

12%, (always given as an annual rate), purchased onJanuary 1.

The natural recording of this interest revenuewill happen when you receive the money.

An income statement for January needs to

show the amount of interest revenue for

January.


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Accruing Interest RevenueAccruing Interest Revenue

Interest = principal x rate x time

Interest = Rs.100 x .12 x 1/12 =

Rs.1

Since the rate is per year, the time hasto be given in terms of a year.

Interest receivable and interest

revenue will each be Rs.1.

Show how that keeps theaccounting equation in balance.


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Accruing Interest RevenueAccruing Interest Revenue


+1 interest +1 interest

receivable revenue

Income Statement:

Statement of Changes in Equity:Statement of Cash Flows:

Increases income

Increases equityNo effect on cash flow


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3.3. An Expense to be AccruedAn Expense to be Accrued

Salary expense is a common expense thatneeds to be accrued before financial statements

are prepared.

Suppose employees work five days per week

and are paid every Friday, but January 31 falls

on a Tuesday.

The salary expense for the week from January

30 to February 3 will not be paid until Friday,

February 3.


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Accruing Salary ExpenseAccruing Salary Expense

The income statement

for January should

have the expense for

January 30 and 31,

while the February

income statement will

have the expense for

February 1, 2, and 3.


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ECONOMICSOFICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTINGOFICMAP STAGE 1,3,4 ICAP

MODULE B, B.COM, BBA, MBA & PIPFA.


CONTACT: 0322-3385752

0312-2302870

0300-2540827

R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,

KARACHI, PAK

ISTA

N.


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Suppose a weeks payroll is Rs.5,000.

On January 31, the company should accrue

Rs.2,000 worth of salary expense.

i.e., 2 out of 5 days worth of the salary must bea January expense.

How is this reflected in the accounting

equation?


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+ 2,000 salaries (2,000) salary

payable expense

Income Statement (Jan.):



Decreases income

Decreases equity



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(5,000) cash (2000) salaries (3000) salarypayable expense

What happens when the salaries areWhat happens when the salaries are

actually paid to the employees onactually paid to the employees on

Friday, February 3?Friday, February 3?

Income Statement (for Feb!):

Statement of Changes in Equity:Statement of Cash Flows:

Decreases income

Decreases equityOperating cash outflow


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4.4. Taxes to be accruedTaxes to be accrued

Tax expense is a common expense that needs

to be accrued when financial statements are

prepared.

The income statement for January needs toinclude the income taxes for January, even

though they will not be paid until several

months later.

WHY??


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What is a Deferral?What is a Deferral?

A deferral event occurs when

cash is received or paid before

revenue is earned or an

expense is incurred.

Deferral events are a part of

the accrual basis ofaccounting


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DeferredDeferred RevenueRevenue

Youve received payment for

something you have NOT yet

provided.

Dollars first, action later. Revenue is not recognized

until the service is performed or

the goods are delivered...but

you have to record the fact thatyou have received the cash.


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Example of deferred revenue:Example of deferred revenue:

A publishing company collects moneyfor magazine subscriptions before the

magazines are actually delivered.

What is exchanged? Cash is received

but the give part will come later.

In the meantime, the company has an

obligation--a liability. (The companygives a promise of future delivery of

magazines.)


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How does receiving a payment inHow does receiving a payment in

advance affect the accounting equation?advance affect the accounting equation?

Assets = Liab. + Cont. Cap. + RetainedEarnings

+ cash + unearnedrevenue

Income Statement:



No effect

No effect

Operating cash flows


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What happens when the service is finallyWhat happens when the service is finally

performed or the goods are delivered?performed or the goods are delivered?


+ cash - unearnedrevenue

Income Statement:



Increases income

Increases equity



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Deferred ExpensesDeferred Expenses

Prepaid ExpensesRent

Insurance

Supplies

Youve paid the cash up-front but you havent

received the goods or services yet.

Remember: DEFER

means to postpone.

Here, we postpone

recognizing the expense

until we actually use the

goods or services.


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Deferred ExpensesDeferred Expenses

Depreciation

ofplantandequipment

Recognizing an expenditure

by spreading it over severalyears, allocating a part of the

expense to each of several

periods during which the asset

is used:

A special deferral--depreciation:


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PREPAID RENTPREPAID RENT

Often companies pay rent in advance.

When the cash is paid, the company

has purchased an asset called

prep

aidrent.

Dollars first--action later.

Whats the action that triggers

recognition of the expense?

Passing of the time to which the rentapplies.


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How does paying the rent in advanceHow does paying the rent in advance

affect the accounting equation?affect the accounting equation?


+ prepaid rent

+ cash

Income Statement:



Decreases income

Decreases equity

Operating Cash Outflows


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The expense is recorded when the time of theThe expense is recorded when the time of the

rent has passedrent has passed when its been used up.when its been used up.U

sually its an adjustment, made when the financialU

sually its an adjustment, made when the financialstatements are being prepared.statements are being prepared.


- Prepaid rent - rent expense

Income Statement:



Decreases income

Decreases equity

No effect on cash flow


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PREPAID INSURANCEPREPAID INSURANCE

Often companies pay insurance in

advance.

When the cash is paid, the company has

purchased an asset called prepaidinsurance.


Whats the action that triggers recognition

of the expense?

Passing of the time to which the insurance

applies.


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How does paying for the insurance inHow does paying for the insurance in

advance affect the accounting equation?advance affect the accounting equation?


+ prepaid insurance

- cash

Income Statement:



No effect

No effect

Operating cash outflow


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The expense is recorded when the time toThe expense is recorded when the time to

which the insurance applies has passedwhich the insurance applies has passed----whenwhen

its been used up.its been used up.Usually its an adjustment, made when the financial statements are

being prepared.


- prepaid - insurance expense

insurance

Income Statement:



Decreases income

Decreases equity



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BUYING SUPPLIESBUYING SUPPLIES

Companies purchase supplies to beused later.

When the cash is paid, the company

has purchased an asset called

supplies. Sometimes they are calledsupplies-on-hand to differentiate them

from supplies expense (used).


Whats the action that triggersrecognition of the expense?

Actually using the supplies.


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How does buying the supplies in advanceHow does buying the supplies in advance

affect the accounting equation?affect the accounting equation?


+ supplies

- cash

Income Statement:



No effect

No effect

Operating cash outflow


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The expense is recorded whenThe expense is recorded when

supplies are used.supplies are used.


- supplies - supplies expense

Income Statement:



Decreases income

Decreases equity


Usually, supplies-on-hand are counted at the end of theperiod, and an adjustment is made to get the amount of

the remaining asset correct for the balance sheet.


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DEPRECIATIONDEPRECIATION

When a company buys an

asset that is used up in the

business (i.e., they didnt buy

it to resell it) AND it will be

useful for more than one

year, GAAP says that the

expense must be spread

over the accounting periods

during the useful life of the

asset.


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DEPRECIATIONDEPRECIATION

The portion of the cost of an assetallocated to any one accounting period--

DEPRECIATION EXPENSE

Depreciation of an asset is

an allocation process--spreading

the cost of an asset that benefits more

than one accounting period over the

estimated useful life of the asset.


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Example of DepreciationExample of Depreciation

ABC Co. bought asatellite dish for

Rs.5,000. The asset is

expected to last five

years and have nosalvage value at the end

of its useful life. How

will the purchase and

use of the asset affectthe financial

statements?


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PurchasePurchase of the asset:of the asset:

How does it affect the financial statements?How does it affect the financial statements?

+5,000 satellite dish

(5,000) cash

Income Statement: no effect

Statement of Changes in Equity: no effect

Statement of Cash Flows: Rs.5,000

investing activity cash outflow

Assets = Liabilities + CC + RE


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We want to allocate the cost of the assetto the income statement as an expenseduring the time period we use the asset.

If we depreciate the asset using theSTRAIGHT LINE method, we will dividethe cost of the asset (minus anyestimated salvage value) by the usefullife: Rs.5,000/5 = Rs.1,000 each year.

USE OF THE ASSETUSE OF THE ASSET


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UseUse of the asset:of the asset:

How does it affect the financial statements?How does it affect the financial statements?

(1,000) (1,000)

reduces the asset expense

Assets = Liabilities + CC + RE

Income Statement:



Reduces income

Reduces equity



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ECONOMICSOFICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTINGOFICMAP STAGE 1,3,4 ICAP

MODULE B, B.COM, BBA, MBA & PIPFA.


CONTACT: 0322-3385752

0312-2302870

0300-2540827

R-1173,ALNOOR SOCIETY, BLOCK 19,F.B.AREA,KARACHI, PAKISTAN.

Documents

Accruals and Deferrals