Accruals and deferrals are used to allocate revenues to the appropriate accounting period along with their related expenses.

Accruals and deferrals are practices used for appropriately recording business transactions that cross over into more than one reporting period. Revenue recognition is based on the time that revenue is earned under accrual accounting, irrespective of whether funds are exchanged or not. Deferred revenue, also called unearned revenue, refers to payments received before the delivery of goods or services. Such income is deferred to the period when a performance obligation is satisfied. Similarly, deferred Expenses, also known as prepaid expenses, refer to advance payment for goods or services. 

• Financial statements would not truly capture a firm’s financial performance or position without accruals and deferrals. For example, if a company rendered services on credit in December but only invoiced its customer in January, an income statement for December without recording the transaction would be understated, whereas that of January would be overstated. By employing accrual-based accounting principles, various revenue and expense transactions will be reported in the correct periods on the financial statements.

Key Examples of Using Accruals and Deferrals to Manage Timing Differences

To record revenue and expenses in the right accounting period, accounting makes use of accruals and deferrals:

Accrued Revenue

• Revenue that has been earned but not billed or received is called accrued revenue. For example, the company offers consulting services in December but only bills the client in January. In this case, revenue should be accrued in December to provide a good reflection of the month’s revenue.

Deferred Revenue

• This refers to monies collected before they have been earned. If your company is scheduled to install windows in a client’s home, for example, and the client pays in advance, this payment should be referred to as deferred revenue until the service is completed. When the service is completed, those funds can then be considered revenue.

Accrued Expenses

• Expenses incurred but not yet paid are called accrued expenses. For instance, XYZ Company receives utilities during December but pays for them in January. To record the accrued expenses, an expense against utilities payable should be recorded during December, even though payment will not be made until January.

Deferred Expenses

• Those costs which have been met before enjoying their fruits are called deferred expenses. One example is paying an insurance premium covering the next twelve months in December. The company should record the amount paid as a deferred expense in December and recognize it as an expense over the next 12 months to match the expense with the period of coverage.