Deferrals Adjusting Entry Overview

Trial Balances and Deferrals

• A deferral is a postponement of revenue or expense recognition.
• A trial balance lists all active accounts and their ending balances, categorized as either debit or credit based on their normal balance.

Types of Trial Balances

• Unadjusted Trial Balance:
  • Prepared at the end of the period.
  • Done after transactions are recorded in the journal and posted to the general ledger.
  • It is the first trial balance.
• Adjusted Trial Balance:
  • Prepared after adjusting entries are recorded.
  • The second trial balance.
• Post-Closing Trial Balance:
  • Prepared after closing entries are recorded.
  • It is the final trial balance.
  • Balances become the beginning balances for the next period.

Purpose of a Trial Balance

• The primary purpose is to show the equality of debits and credits.
• It doesn't guarantee that all transactions are recorded or correctly categorized; it only confirms that the accounting equation (Assets = Liabilities + Equity) is in balance.

Accrual Basis Accounting

• Under accrual accounting (required by GAAP), revenues and expenses are recognized when earned or incurred, regardless of when cash changes hands.
• This system creates receivables and payables.

Adjusting Entries

• Adjusting entries are necessary at the end of a period to:
  • Update accounts.
  • Ensure proper revenue and expense recognition in the correct accounting period.
  • Match resources used with earned revenue in the same period.
• Made after the unadjusted trial balance.

Types of Adjustments

• Accruals and Deferrals.

Accruals

• Cash has not yet been received or paid.
• For example, recognizing a receivable when service is provided without immediate payment.

Deferrals

• Cash has already been exchanged (received or paid).
• It is a postponement of revenue or expense recognition.

Revenue Deferral

• Occurs when a customer pays in advance, but the service or product has not yet been provided.

Expense Deferral

• Occurs when an asset (e.g., supplies) is purchased, but the expense is deferred until the asset is used.

General Rule for Adjusting Entries

• Each adjusting entry affects one income statement account and one balance sheet account.
• Cash is never affected in adjusting entries.

Deferred Revenues (Unearned Revenues)

• Cash is received before the service or product is provided.
• Initially, cash and unearned revenue (a liability) are increased.

Adjusting Entry for Deferred Revenue

• Made at the end of the period when the service or product is provided.
• The liability (unearned revenue) is decreased (debited), and revenue is recognized (credited).

Accounting Equation Effects for Deferred Revenues Adjusting Entry

• Debit (Decrease) to Liabilities (Balance Sheet).
• Credit (Increase) to Equity (Revenue Account, Income Statement).
• No effect on assets.

Deferred Expenses (Prepaid Expenses)

• Expense is paid in advance, but the benefit (resource usage) is deferred until later.
• Initially, an asset (e.g., prepaid insurance) is increased, and cash is decreased.

Adjusting Entry for Deferred Expenses

• Made at the end of the period when the asset (or part of it) is consumed or used.
• An expense account is debited, and the asset account is credited.

Accounting Equation Effects for Deferred Expenses Adjusting Entry

• Debit (Increase) to Expense (Income Statement).
• Credit (Decrease) to Assets (Balance Sheet).
• Expenses decrease equity.

Review of Deferrals

• Deferrals involve cash transactions occurring before revenue or expense recognition.
• Revenue recognition is postponed until earned.
• Expense recognition is postponed until the asset is consumed.

Effects of Deferred Revenue

• Decrease in liability (unearned revenue) on the balance sheet.
• Increase in revenue on the income statement.

Effects of Deferred Expenses

• Increase in expense on the income statement (decreasing equity).
• Decrease in the asset on the balance sheet.

Key points to remember:

• Every adjusting entry impacts both the income statement and balance sheet.
• Cash is never affected by adjusting entries.