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21 Accrual & Deferral Concept

The document explains the concepts of accruals and deferrals in accounting, highlighting their definitions, differences, and importance in financial reporting. Accruals recognize expenses and revenues when incurred or earned, while deferrals recognize them when paid or received. The document also provides examples and interview questions related to these accounting practices to enhance understanding and application.

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14 views

21 Accrual & Deferral Concept

The document explains the concepts of accruals and deferrals in accounting, highlighting their definitions, differences, and importance in financial reporting. Accruals recognize expenses and revenues when incurred or earned, while deferrals recognize them when paid or received. The document also provides examples and interview questions related to these accounting practices to enhance understanding and application.

Uploaded by

saitejamoneymaker
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Accruals vs Deferrals

Things we will Cover


Today:

What are What are Why they are


Accruals? Deferrals? Important?

What is the Most Important


Examples of
difference Interview
Accruals and
between Accruals Questions with
Deferrals?
and Deferrals? Answers.
What are Accruals?
Accruals are expenses that have been incurred
but not yet paid, or revenue that has been
earned but not yet collected.
For Example:
Let's suppose you are staying in a rented house, and you have
not paid the rent for this month yet, in that case you need to
record the rent expense by creating a current liability of
Outstanding Rent/Rent Payable.

Rent Account DR
TO Rent Payable Account
For Example:
If you sell a product in November but don't
receive payment until December, you will accrue
revenue for the sale in November.

Accounts Receivable Account DR


TO Sales Account
What are Deferrals?
Deferrals are the opposite of
accruals. They are expenses that
have been paid but not yet
incurred, or revenue that has
been collected but not yet
earned.
For Example:
Let's suppose you are staying in a rented house, and you have
paid the rent for this month in advance, in that case you need
to record the transaction by creating a current assets of
Prepaid Rent against the Cash outflow.

Prepaid Rent Account DR


TO Cash Account
For Example:
If you sell a product in December but have
already received the payment in November,
you will need to record this as unearned
Revenue or Advance.
Bank Account DR
TO Unearned Income Account
Importance of Accruals & Deferrals
Accruals and deferrals are
important because they help to
match revenue and expenses to
the period in which they were
earned or incurred. This is
important for providing an
accurate picture of a company's
financial performance.
Difference B/W Accruals & Deferrals
Accruals are recognized in the Deferrals are recognized in the
period earned or incurred, period paid or received,
regardless of when paid or regardless of when earned or
received. incurred.
Examples of Accrual
Wages expense: This is the expense of wages that have been earned by
employees but not yet paid.

Interest expense: This is the expense of interest that has accrued on a loan but
not yet been paid.

Rent expense: This is the expense of rent that has been incurred but not yet paid.

Sales tax payable: This is the liability for sales tax that has been collected from
customers but not yet paid to the government.
Examples of Deferral
Prepaid rent: This is the asset of rent that has been paid in advance but not yet
incurred.

Unearned revenue: This is the liability of revenue that has been collected but not
yet earned.

Prepaid insurance: This is the asset of insurance that has been paid in advance but
not yet incurred.
Important Interview Questions
1. What is the difference between an accrual and a deferral?
2. Can you give an example of an accrual?
3. Can you give an example of a deferral?
4. Why are accruals and deferrals important?
5. How do accruals and deferrals affect a company's financial statements?
6. Can you explain the concept of accrual accounting and its importance in financial
reporting?
7. Give an example of when accrual accounting is applied in a business scenario.
8. How do deferrals impact the recognition of revenue or expenses in financial
statements?
9. Provide a real-world example where deferral accounting is relevant.
10. Why is it important for companies to use accruals and deferrals in their accounting
practices?
What is the difference between an accrual and a
deferral?
Accruals and deferrals are both accounting adjustments that help match revenue
and expenses to the periods in which they were earned or incurred. The key
distinction lies in the timing of recognition:

Accruals: Accruals recognize revenue when it is earned, regardless of when cash is


received, and recognize expenses when they are incurred, regardless of when cash
is paid.

Deferrals: Deferrals recognize expenses when they are paid, but not yet incurred,
and recognize revenue when it is collected, but not yet earned.
Can you give an example of an Accrual?
Certainly. An example of an accrual
would be a consulting firm
providing services in December but
invoicing the client in January. The
accrual occurs in December when
the services are rendered, even
though the payment is received
later.
Can you give an
example of a
Deferral?
1. Of course. Imagine a software company
selling annual licenses. If a customer pays for
the license upfront in January, but the
software is delivered and utilized over the
entire year, the revenue recognition is
deferred each month to reflect when the
customer is actually benefiting from the
software.
Why are accruals
and deferrals
important?
1. Accruals and deferrals are crucial for
accurate financial reporting. They ensure
that financial statements portray the
economic reality by matching revenues
and expenses with the periods in which
they occur. This provides stakeholders
with a more realistic and comprehensive
view of a company's financial
performance.
How do accruals and
deferrals affect a
company's financial
statements?
1. Accruals and deferrals impact
financial statements by ensuring that
revenues and expenses are
recognized in the appropriate
accounting periods. Accruals allow for
the recognition of revenue or
expenses when they are incurred, not
just when cash changes hands.
Deferrals postpone recognition until
the related goods or services are
provided.
Can you explain the concept 1. Accrual accounting is the method of recording
financial transactions when they occur,
of accrual accounting and its regardless of the cash flow timing. It is crucial
importance in financial for financial reporting as it provides a more
accurate representation of a company's
reporting? financial position and performance over time,
offering insights into its ongoing business
activities.
Give an example of when accrual accounting is applied
in a business scenario.
Let's say a manufacturing company purchases raw materials on credit in
December but pays for them in January. With accrual accounting, the
company recognizes the expense in December when the materials are
received, ensuring a more accurate reflection of the costs associated
with production.
How do deferrals impact the recognition of revenue or
expenses in financial statements?
Deferrals influence financial
statements by delaying the recognition
of revenue or expenses until the cash
transaction takes place or the related
goods or services are provided. This
approach ensures that financial
statements accurately reflect the
timing of economic events, providing a
clearer picture of a company's
financial health.
Provide a real-world example where deferral
accounting is relevant?
Sure, lets consider a software company
that sells subscriptions for example
SAP. If a customer pays for a one-year
subscription upfront, deferral
accounting spreads the recognition of
revenue over the subscription period,
aligning with the ongoing delivery of
software updates and customer
support throughout the year.
Why is it important for 1. Accruals and deferrals are integral because they
enhance the accuracy and reliability of financial

companies to use accruals statements. By matching revenues and


expenses to the periods in which they occur,
and deferrals in their these accounting practices provide
stakeholders, such as investors and
accounting practices? management, with a more informative and
realistic portrayal of a company's financial
performance, aiding in better decision-making.
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