Accrual accounting and timing

Learning goals

• Distinguish cash timing from earning and incurring.
• Identify accrued revenue, accrued expense, deferred revenue, and prepaid expense situations.
• Determine what has changed by the reporting date.
• Explain the statement effects of omitted adjustments.

Prerequisite check

What entry records a $1,200 customer deposit before work is done? What changes when $300 of that work is completed?

Vocabulary

• Accrual basis: recognizes revenue when earned and expenses when incurred.
• Adjustment: period-end update for information not fully reflected in daily entries.
• Accrued revenue: revenue earned before it is recorded or collected.
• Accrued expense: expense incurred before it is recorded or paid.
• Deferred/unearned revenue: cash received before revenue is earned; initially a liability.
• Prepaid expense: cash paid before the benefit is used; initially an asset.
• Cutoff: assigning transactions and adjustments to the correct reporting period.

Core idea

Cash asks when money moved. Accrual accounting asks when performance occurred, an obligation arose, or a benefit was used. Adjustments bring the records to the reporting date without inventing activity.

Why this treatment makes sense

Cash can move early or late. If an annual contract paid in advance became expense immediately, one month would absorb the cost of many months. If completed work waited for collection before becoming revenue, customer payment habits would decide reported performance.

A repeatable method

At the reporting date, ask:

1. What asset, liability, revenue, or expense balance is already recorded?
2. What does current evidence say is earned, incurred, used, or still owed?
3. What should the ending balance be?
4. Difference = adjustment.
5. Record one income-statement account and one balance-sheet account in the usual adjustment.
6. State the effect if omitted.

Worked example

At March 31, Cedar Coast Design finds two timing items.

A. Earned but not billed: Design work of $750 was completed and approved on March 30. Billing occurs April 2.

The adjustment raises assets, revenue, and net income by $750. If omitted, all three are understated.

B. Customer deposit partly earned: Unearned Revenue has a $1,200 credit from cash received earlier. By March 31, $400 of work is complete.

The remaining liability is $800. The adjustment increases revenue and equity $400 and reduces liabilities $400. Cash does not change in either adjustment.

Reasonableness: total supported service earned in these two items is $750 + $400 = $1,150. One created a receivable; the other used part of an existing obligation.

Journal, ledger, and statement connection

Daily entries produce an unadjusted trial balance. Period-end evidence creates adjusting journal entries, which post to ledgers and produce adjusted balances. Only adjusted revenue, expenses, assets, and liabilities belong in the formal statements.

Common mistakes

• Waiting for an invoice or cash movement when the problem clearly says an amount is earned or incurred.
• Crediting Cash when earning part of an existing customer deposit.
• Debiting Cash for accrued revenue that has not been collected.
• Reducing the entire Unearned Revenue balance when only part was earned.
• Adjusting toward a desired profit instead of an evidence-supported ending balance.

Guided practice

Identify the type and entry.

1. Employees have earned $620 by year-end, payable next week.
2. A $2,400 twelve-month insurance policy paid two months ago has not been adjusted.
3. A $900 customer deposit remains entirely unearned at the reporting date and was originally credited to Unearned Revenue.
4. $350 of consulting is complete but not yet billed.

Independent practice

At December 31, Alpine Tech Help has:

• $1,800 in Unearned Revenue, of which $1,050 is now earned;
• $480 utilities used but not billed;
• $600 services complete but not yet billed.

Prepare adjustments and state the combined effect on net income, assets, and liabilities.

Self-check and solutions

Guided practice:

1. Accrued expense: Dr Wages Expense $620; Cr Wages Payable $620.
2. Prepaid expense used: $2,400 ÷ 12 × 2 = $400. Dr Insurance Expense $400; Cr Prepaid Insurance $400.
3. No adjustment is needed because the existing $900 liability matches the evidence; confirm rather than forcing an entry.
4. Accrued revenue: Dr Accounts Receivable $350; Cr Service Revenue $350.

Independent practice: Dr Unearned Revenue $1,050 / Cr Service Revenue $1,050; Dr Utilities Expense $480 / Cr Utilities Payable $480; Dr Accounts Receivable $600 / Cr Service Revenue $600. Net income rises by $1,050 + $600 − $480 = $1,170. Assets rise $600. Liabilities decrease $1,050 then increase $480, a net decrease of $570. Equity rises $1,170; equation check: asset increase $600 = liability change −$570 + equity increase $1,170.

Retrieval practice

Draw a four-box timing map: accrued revenue, accrued expense, unearned revenue, prepaid expense. For each, show whether cash is early or late and name the balance-sheet account.

Exam-style application

The owner says, “Adjustments are fake because no new cash moved.” Respond and include one omitted-adjustment effect.

Answer outline: Adjustments do not invent cash; they update accounts for earning, incurring, using, or remaining obligations by a reporting date. Source evidence such as contracts, counts, time records, or invoices supports them. Omitting accrued wages understates expenses and liabilities and overstates profit. Cash stays unchanged, which is precisely why a separate adjustment is needed.

Lesson summary

Accrual accounting reports economic activity in the period it occurs. Determine the supported ending balance, adjust the difference, and explain what would be wrong without it.