DEFFERALS & ACCRUALS

PERIODICITY CONCEPT

 To provide timely information, accountants have divided the

economic life of a business into artificial time periods. This
assumption is referred to as the periodicity concept.
 Accounting periods are generally a month, a quarter or a year. The
most basic accounting period is one year.
 A fiscal year - a period of any twelve consecutive months.
 A calendar year - an annual period ending on December 31.
 A natural business year - a twelve-month period that ends when
business activities are at their lowest level of the annual cycle.
 An interim period –a period less than a year
 ACCRUAL BASIS vs. CASH BASIS

ACCRUAL BASIS- the effects of

transactions and other events are
recognized when they occur and not as
cash is received or paid
revenues as they are earned and
expenses as they are incurred
 ACCRUAL BASIS vs. CASH BASIS

CASH BASIS – a transaction is not

recorded until cash is received or paid
Cash basis income is the difference
between operating cash receipts and
disbursements.
 ACCRUAL BASIS vs. CASH BASIS

 Illustration: A client paid the Blue Coral Resort in Palawan Island P 7,000
on April 8, 2018 for a one-day super deluxe accommodation of May 13,
2018. Under accrual basis of accounting, the receipt of P 7,000 will be
considered as revenues when the business has rendered its services on
May 13.
 In contrast, if cash basis is used, the hotel will recognize revenues on April
8. Expenses related to this revenue transaction will be incurred on May 13.
Suppose a financial report is prepared at the end of April, under accrual
basis, no revenue or expense will be reported; under cash basis, revenues
of P 7,000 will be reported but the related expenses will be recognized
when incurred on May 13. Observe that the accrual basis provided a
better measure of the results of transaction.
 RECOGNITION & DERECOGNITION

 Recognition links the elements, the statement of

financial position and the statement of financial
performance. The statements are linked because
the recognition of one item (or a change in its
carrying amount) requires the recognition or
derecognition of one or more other items (or
changes in the carrying amount of one or more
other items).
 RECOGNITION & DERECOGNITION

 (a) the recognition of income occurs at the same time as:

(i) the initial recognition of an asset, or an increase in the carrying
amount of an asset; or
(ii) the derecognition of a liability, or a decrease in the carrying
amount of the liability
 (b) the recognition of expenses occurs at the same time as:
(i) the initial recognition of a liability, or an increase in the carrying
amount of a liability; or
(ii) the derecognition of an asset, or a decrease in the carrying
amount of an asset
 RECOGNITION & DERECOGNITION

 Derecognition is the removal of all or part of a recognized

asset or liability from an entity’s statement of financial
position. Derecognition normally occurs when that item no
longer meets the definition of an asset or of a liability.
 (a) for an asset, derecognition normally occurs when the
entity loses control of all or part of the recognized asset; and
 (b) for a liability, derecognition normally occurs when the
entity no longer has a present obligation for all or part of the
recognized liability.
 DEFERRALS AND ACCRUALS

 Deferral is the postponement of the recognition of “an expense already

paid but not yet incurred’, or of a “revenue already collected but not
yet earned”. This adjustment deals with an amount already recorded in
a balance sheet account; the entry, in effect, decreases the balance
sheet account and increases an income statement account. Deferrals
would be needed in two cases:
1. Allocating assets to expense to reflect expenses incurred during the
accounting period (e.g. prepaid insurance, supplies and depreciation).
2. Allocating revenues received in advance to revenue to reflect revenues
earned during the accounting period.
 DEFERRALS AND ACCRUALS

 Accrual is the recognition of “an expense already incurred but

unpaid” or “revenue earned but uncollected”. This adjustment deals
with an amount unrecorded in any account; the entry, in effect,
increases both a balance sheet and an income statement account.
Accruals would be required in two cases:
1. Accruing expenses to reflect expenses incurred during the
accounting period that are unpaid and unrecorded.
2. Accruing revenues to reflect revenues earned during the
accounting period that are uncollected and unrecorded.
 ADJUSTMENT FOR DEFERRALS

Prepaid Rent
On Aug. 1, Masterpiece Events and Creative paid P16,000 for two
months’ rent in advance. This expenditure resulted to an asset
consisting of the right to occupy office for two months. A portion of the
asset expires and becomes an expense each day. By Aug. 31, one-
half of the asset had expired, and should be treated as an expense.
Transaction Expiration of one month’s rent
Analysis Assets decreased. Owner’s equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in
owner’s equity are recorded by debits.
 PREPAID RENT

Entries Decrease in owner’s equity is recorded by a debit to

rent expense. Decrease in assets is recorded by a credit to prepaid
rent.
Dr. Cr.
Rent Expense (OE:E) 8,000
Prepaid Rent (A) 8,000

After adjustments, the prepaid rent account has a balance of

P8,000 (Aug.1 prepayment of P16,000 less the P8,000 expired
portion); the rent expense reflects the P8,000 expense for the month.
 ADJUSTMENT FOR DEFERRALS

Prepaid Insurance
On Aug. 4, Masterpiece Events and Creative acquired a one-year
comprehensive insurance coverage on the service vehicle and paid P
28,800 premiums. In a manner similar to prepaid rent, prepaid insurance
offers protection that expires daily.
Transaction Expiration of one month’s insurance
Analysis Assets decreased. Owner’s equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in
owner’s equity are recorded by debits.
 PREPAID INSURANCE

Entries Decrease in owner’s equity is recorded by a debit to insurance

expense; decrease in assets as a credit to prepaid insurance.
Dr. Cr.
Insurance Expense (OE:E) 2,400
Prepaid Insurance (A) 2,400

The prepaid insurance account has a balance of P 26,400 (Aug. 4

prepayment of P 28,800 less P 2,400) and insurance expense reflects the
expired cost of P 2,400 for the month. As a matter of company policy, the
period Aug. 4 to 31 is considered a month.
 ADJUSTMENT FOR DEFERRALS

Supplies
On Aug. 8, Masterpiece Events and Creative purchased supplies, P 36,000. During
the month, the entity used supplies in the process of performing services for clients.
There is no need to account for these supplies every day since the financial
statements will not be prepared until the end of the month. At the end of the
accounting period, Evangelista makes a physical inventory of the supplies. The
inventory count showed that supplies costing P 30,000 are still on hand.
Transaction Consumption of supplies
Analysis Assets decreased. Owner’s equity decreased.
Rules Decreases in assets are recorded by credits. Decreases in
owner’s equity are recorded by debits.
 SUPPLIES

Entries Decrease in owner’s equity is recorded by a debit to

supplies expense. Decrease in assets is recorded by a credit to
supplies.
Dr. Cr.
Supplies Expense (OE:E) 6,000
Supplies (A) 6,000
The asset account supplies now reflect the adjusted amount P 30,000
(P 36,000 less P 6,000). In addition, the amount of supplies expensed
during the accounting period is reflected as P 6,000.
 Depreciation of Property and
Equipment

Depreciation expense- The portion or cost or tangible asset

allocated or charged as expense in an accounting period. Factors
in the computation of deprecation expense
 1. Asset cost - the amount an entity should paid to acquire the
depreciable asset.
 2. Estimated salvage value - the amount that the asset can
probably be sold for at the end of its estimated useful life.
 3. Estimated useful life - the estimated number of periods that an
entity can make use of the asset. Useful life is an estimate, not an
exact measurement.
 Depreciation of Property and
Equipment

 Accumulated depreciation – contains the

sum of the periodic depreciation charges
and the balance of this account is
deducted from the cost of the related asset
to obtain the book value.
 ADJUSTMENT FOR DEFERRALS

Service Vehicle and Office Equipment

Masterpiece Events and Creative estimated that the service vehicle, which was
bought on . Aug 4, will last for seven years (eighty-four months) and with a salvage
value of P 84,000. The office equipment that was acquired on Aug. 5 will have a useful
life of five years (sixty months) and will be worthless at that time. Substitution of the
pertinent amounts into the basic formula will yield depreciation for service vehicle and
office equipment for the month as P 4,000 [(P420,000 – P84,000)/84 months] and P 1,000
(P 60,000/60 months), respectively. This amounts represent the cost allocated to the
month, thus reducing the asset accounts and increasing the expense accounts. As a
matter of company policy, the period August 4 to 31 is considered a month.
 Depreciation of Service Vehicle and
Office Equipment
Transaction Recording depreciation expense
Analysis Assets decreased. Owner’s equity decreased.
Rules Decreases in assets are recorded by credits.
Decreases in owner’s equity are recorded by debits.
Entries Owner’s equity is decreased by debits to
depreciation expense – service vehicle and depreciation expense
– office equipment.
Assets are decreased by credits to contra-asset accounts
accumulated depreciation-service vehicle and accumulated
depreciation-office equipment.
 Depreciation of Service Vehicle and
Office Equipment

Dr. Cr.

Depreciation Expense – Service Vehicle (OE:E) 4,000

Accumulated Depreciation – Service Vehicle (A) 4,000

Depreciation Expense – Office Equipment (OE:E) 1,000

Accumulated Depreciation –Office Equipment (A) 1,000
Depreciation of Service Vehicle and
Office Equipment
 ADJUSTMENT FOR DEFERRALS

Unearned Referral Revenues

On Aug. 15, Masterpiece Events and Creatives received a P 20,000 as an advance
payments for referrals made. Assume that by the end of the month, one of the three
couples referred has already taken their marriage vows and as a result the amount P
8,000 pertaining to the referred event has been realized.

Transaction Recognition of income where cash is received in advance.

Analysis Liabilities decreased. Owner’s equity increased.
Rules Decreases in liabilities are recorded by debits. Increases in owner’s
equity are recorded by credits.
 Unearned Referral Revenues

Entries Decrease in liabilities is recorded by a debit to unearned

referral revenues. Increase in owner’s equity is recorded by a credit
to referral revenues.
Dr. Cr.
Unearned Referral Revenues P 8,000
Referral Revenues P 8,000
The liability account unearned referral revenues reflects the referral
revenues still to be earned, P 12,000. The referral revenues account
reflects the amount of referrals already completed and considered
as revenues during the month, P 8,000.
 ADJUSTMENT FOR ACCRUALS
–Accrued Salaries
 Accrued Salaries
Masterpiece Events and Creative paid salaries every two weeks. The business has 10 employees
with a salary of P 400 per day. As of Aug 31,The employees have earned salary for 5 days but it
is not due to be paid until the regular pay day on September. The accrued expense can be
analyzed as:
Transaction Accrual of an unrecorded expense.
Analysis Liabilities increased. Owner’s equity decreased.
Rules Increases in liabilities are recorded by credits. Decreases in owner’s equity
are recorded by debits.
Entries Decreases in owner’s equity are recorded by debit to Salaries expense. Increases in
liabilities are recorded by credit to Salaries Payable
Dr. Cr.
Salaries Expense (OE:E) P 20,000
Salaries Payable (L) P 20,000
 ADJUSTMENT FOR ACCRUALS
–Accrued Interest
On Aug. 2, 2018, Rosales, the owner of Masterpiece Events and Creative borrowed P 300,000
from EastWest Bank. The note carried 15% interest per annum with both principal and interest
due in 1 year. At the end of the month, the Rosales owed the bank P 3,750 for the interest
incurred during the month. The adjusting entry would be:
Transaction Accrual of an unrecorded expense.
Analysis Liabilities increased. Owner’s equity decreased.
Rules Increases in liabilities are recorded by credits. Decreases in owner’s equity
are recorded by debits.
Entries Decreases in owner’s equity are recorded by debit to Interest expense. Increases in
liabilities are recorded by credit to Interest Payable
Dr. Cr.
Interest Expense (OE:E) P 3,750
Interest Payable (L) P 3,750
 ACCRUED REVENUES

Masterpiece Events & Creative agreed to arrange a rush services. The entity
intended to charge fees of P10,000 which is earned but unbilled.
Transaction Accrual of an unrecorded expense
Analysis Assets increased. Owner’s equity increased.
Rules Increased in asset are recorded by debits. Increase in
owner’s equity are recorded by credits.
Entries Increased in asset are recorded by debit to accounts
receivable. Increase in owner’s equity are recorded by credit to consulting
revenues.
ACCRUED REVENUES

Dr. Cr.
Accounts Receivable (A) P10,000
Consulting Revenue (I:OE) P10,000
 ACCRUAL FOR UNCOLLECTIBLE
ACCOUNTS

 Masterpiece Events and Creative made services for credit P 350,000 and
estimate 1% allowance for uncollectible accounts.

Dr. Cr.
Uncollectible Account Expense (OE: E) P 3,500
Allowance for Uncollectible Accounts (A) P 3,500
 ACCRUAL FOR UNCOLLECTIBLE
ACCOUNTS

 Masterpiece Events and Creative found out that

P 1,000 is definitely uncollectible:
Allowance for Uncollectible Accounts P 1,000
Accounts Receivable P 1,000