Study Zone Institute Teaching and learning made easy
Accruals are monies owed either by the business or to the business. This happens when the business does not pay cash for expenses incurred within the accounting period or when cash is not received for income earned within the accounting period.
The accrual/matching concept is the principle that states expenses must match the income for a particular period whether no money or too much money is involved. Therefore, adjustments have to be made for accruals of expenses and revenues.
When students are given questions that involve accruals, you must be able to record transactions in the accounting cycle. Here is a breakdown with examples.
Accruals in the accounting cycle
Expense
Transaction: On December 31, 2023 a business rents a building to operate for $1 000 a year but only pays $800 cash.
What you must do
Source Documents
Find the source documents involved in this transaction.
1. Rent invoices totalling $1 000 received from the landlord
2. Cash receipts totalling $800 for monies paid to the landlord
Journal
There are two journals involved in this transaction. The General Journal records rent incurred for the year and the Cash Book records monies paid for the year. The Cash Book is both a journal and ledger. When there is a Cash account in the General Ledger, there is no need for a Cash Book.
In the General Journal, debit Income Statement with $1 000 and credit Rent with $1 000. Rent is an expense account and expenses incurred are debited in the Income Statement to be subtracted from Revenue.
In the Cash Book, credit the details column with Rent and the cash column with $800. Remember that when money leaves the business, the Cash Book is credited.
Ledger
In the General Ledger, a Rent account is opened. On the debit side, record Cash $800 to complete the double entry as you have already credited the Cash Book with Rent $800. Remember that expense accounts have debit balances.
On the credit side of the Rent account, record Income Statement $1 000 to complete the double entry as you have already debited the Income Statement with Rent $1 000 in the journal. Remember that expense accounts in the Income Statement have debit balances.
Calculate the difference between the debit and credit sides of the Rent account. The $200 difference goes under $800 on the debit side as balance carried down.
In the following year, the rent account has a credit balance brought down of $200. Expense accounts with credit balances are called Current Liabilities in the financial statements.
Income Statement
In the Income Statement, record Rent $1 000 under the Expenses heading. This figure along with other expenses are then subtracted from the Gross Profit to get Net Profit for the year.
It does not matter if the full amount was paid to the landlord, the Income Statement records the expense that was used up for the year. Prepayments and accruals are shown in the Balance Sheet.
Balance Sheet
In the Balance Sheet or Statement of Financial Position, under the Current Liabilities heading, record Accruals (rent) $200. This figure along with Creditors will be subtracted from the Current Assets total to find the Working Capital or Net Current Assets.
Look at it this way, the Cash figure under the Current Assets heading will not include $800 because it was deducted in the Cash Book and never made it to the Balance Sheet.
The $200 to be subtracted in liabilities will also be eliminated. These figures total the $1 000 that was supposed to be paid for rent incurred for the year.
Revenue
Transaction: On December 31, 2023 a business called ABC charges rent to a food business to use cafeteria space inside of the building that ABC owns for $3 000 a year, but ABC only receives cheques for $2 000 from the food business.
What you must do
Source Documents
Find the source documents involved in this transaction.
1. Rent invoices totalling $3 000 issued to the tenant
2. Receipts totalling $2 000 for cheques received from tenant
Journal
There are two journals involved in this transaction. The General Journal records rent revenue earned for the year and the Cash Book records monies received for the year. The Cash Book is both a journal and ledger. When there is a Cash account in the General Ledger, there is no need for a Cash Book.
In the General Journal, debit Rent Revenue with $3 000 and credit Income Statement with $3 000. Rent Revenue is an income account and revenue earned is credited in the Income Statement to be added to other income.
In the Cash Book, debit the details column with Rent Revenue and the bank column with $2 000 because cheques have to pass through the bank. Remember that when money comes into the business, the Cash Book is debited.
Ledger
In the General Ledger, a Rent Revenue account is opened. On the credit side, record Bank $2 000 to complete the double entry as you have already debited the Cash Book with Rent Revenue $2 000. Remember that income accounts have credit balances.
On the debit side of the Rent Revenue account, record Income Statement $3 000 to complete the double entry as you have already credited the Income Statement with Rent Revenue $3 000 in the journal. Remember that income accounts in the Income Statement have credit balances.
Calculate the difference between the debit and credit sides of the Rent Revenue account. The $1 000 difference goes under $2 000 on the credit side as balance carried down.
In the following year, the Rent Revenue account has a debit balance brought down of $1 000. Income accounts with debit balances are called current assets in the financial statements.
Income Statement
In the Income Statement, record Rent Revenue $3 000 under the Other Revenue heading. This heading is found in a multi-step Income Statement that shows operational income and expenses separate from non-operational income and expenses.
Students of basic accounting may hardly be required to use this type of Income Statement. If, however, you are asked to record revenue that is not part of the operating income, simply record it just before the Expenses heading.
It does not matter if the full amount was received, the Income Statement records the income that was earned while the tenant used the space for the year. The amount must be recorded after Gross Profit as it is not part of Sales. Cheques received and accruals are shown in the Balance Sheet.
Balance Sheet
In the Balance Sheet or Statement of Financial Position, under the Current Assets heading, record Accruals (rent) $1 000. This figure along with the Bank figure that includes $2 000 and all other Current Assets will subtract Current Liabilities to find the Working Capital or Net Current Assets.
Look at it this way, the total of $3 000 Rent Revenue is shown under Current Assets. It is split into the Bank figure under the Current Assets heading that includes $2 000 because it was added in the Cash Book and the Accrued Rent Revenue $1 000.
Conclusion
Accruals are monies owed that need adjustment accounts to be recorded in the Accounting Cycle. When recording incurred expenses in the journal, the Income Statement is debited and the expense account is credited. When recording earned revenue in the journal, the Income Statement is credited and the revenue account is debited.
For the ledger entries, expense accounts have debit balances so an expense account with a credit balance is an accrued expense. Revenue accounts have credit balances so a revenue account with a debit balance is an accrued revenue.
In the Income Statement, the full amount for expenses incurred and income earned are recorded. In the Balance Sheet, the amounts paid or received are shown or deducted from either Cash or Bank, and accrued expense is a current liability while accrued revenue is a current asset.
See also:
You must be logged in to post a comment.