Accruals and Deferrals: Definition and Differences

According to generally accepted accounting principles (GAAP), firms must record revenue when it is earned and expenses when they are incurred. To Comply with accounting standards, accrual, and deferral procedures are employed when the timing of payment differs from when it is received or a cost is incurred.

Accrual basis accounting is widely accepted as the standard method of accounting. To offer uniformity and transparency in reporting for investors and creditors to evaluate businesses, the Securities and Exchange Commission (SEC) requires all public companies to use accrual basis accounting and comply with GAAP.

So, what is the distinction in accounting between the accrual approach and the deferral technique? Let’s look at both approaches, walk through some cases, and look at the fundamental differences.

deferral vs. accrual

Accruals occur after a good or service has been supplied, whereas deferrals occur before a good or service has been delivered. An accrual moves a current transaction into the current accounting period, whereas a deferral moves a transaction into the next period.  

key differences between accrual and deferral

Here are some essential distinctions between accrual and deferral accounting procedures.

timing

• Accrual: Things that happen before payment and reception
• Deferral: This occurs after revenue has been paid or received.

expenses

• Accrual: Accrual expenses are those that have been incurred but have yet to be reimbursed (for example, accounts receivable).
• Deferral: Expenses that have been paid but have not been incurred (for example, prepaid accounts).

payments

• Accrual: There is no monetary payment.
• Deferral: There is a cash advance payment.

revenue

• Accrual revenue is revenue that has been earned but has not yet been paid (for example, accounts payable).
• Deferral: Deferred revenue is revenue that has been received but has not yet been incurred (for example, a deposit or prepayment).

revenue vs. expense

• Accrual: Expenses are decreasing while revenue is increasing.
• Deferral: There is an increase in expenses and a drop in revenue due to deferral.

Revenue is recognized in the income statement before it is received in an accrual system. A deferral system seeks to reduce the debit account while crediting the revenue account.

 

What Exactly is Accrual? Using the accrual accounting approach yields the following results: • Accrued expenses are reported now, but expense payment comes later. • Accrued revenues are reported at the moment of sale, but payments are still being processed.

What Exactly is a Deferral? Using deferral accounting procedures yields the following results: Deferred expenditures are paid for now but aren’t reported until a later accounting period. Deferred revenue is money that comes in now but isn’t reported until a later accounting period.

 

Accrued Expense  You have accumulated expenses if you have incurred them but have yet to pay them. For example, you must pay for the electricity you used in December but will not receive your bill until January. You would record the expense in December and then credit the account as an accumulated expense due when payment is received in January.

Deferred Expense A deferred expense is one that is paid in advance before you use the services. For instance, you may pay for property insurance for the coming year before the policy goes into effect. During each accounting period, you would recognize the payment as a current asset and debit the account as an expense.

 

Accrual Expense Example An example of expense accrual is an emergency repair required due to a pipe burst. You would hire a plumber to fix the leak but not pay until you received an invoice, say, in a later month. The liability would be documented by deducting $10,000 from costs and crediting $10,000 to accounts payable. When the bill is received and paid, it is entered as $10,000 to debit accounts payable and $10,000 to credit cash.

Deferred Expense Example A deferred expense is when you pay for services in advance. The payment has been made, but the services have not been provided. This would be recorded as a $10,000 debit to prepaid costs and a $10,000 credit to cash. When the services are done, you will deduct $10,000 from expenses and credit $10,000 from prepaid expenses.

 

Accrued Revenue When you record accumulated revenue, you recognize the amount of income that is owed to you but has not yet been paid. For example, suppose you sell something in March but don’t get paid until May. You would record the revenue produced in March, and the payment received in March would offset the entry.

Deferred Revenue  Deferred revenue is money you get before earning it. For instance, a client may pay you an annual retainer in advance, which you can draw on as needed. Revenue is not reported in this scenario until it is earned. Instead, it would be represented as a current liability, with income reported as revenue as services are supplied.

 

Revenue Accrual Example Revenue accrual happens when you sell your product for $10,000 in one accounting period but only get paid for it before the end of the period. You would record the transaction by debiting accounts receivable and crediting revenue by $10,000. When the bill is paid, the entry is modified by deducting $10,000 from cash and crediting $10,000 from accounts receivable.

Deferred Revenue Example Assume a customer makes a $10,000 advance payment in January for products you’re making to be delivered in April. You would record it as a $10,000 debit to cash and a $10,000 deferred revenue credit. The receipt of payment has no bearing on when revenue is received using this method. When the products are delivered, deduct $10,000 from deferred revenue and credit $10,000 to earned revenue.

the value of accrual and deferral

Accrual and deferral procedures are vital because they keep revenues and costs in sync. Accounting for accrual and deferral plays a vital role in appropriately matching revenue and costs.

Using these strategies regularly helps someone looking at a balance sheet comprehend an organization’s financial health during the accounting period. It also assists business owners and managers in measuring and analyzing activities as well as understanding financial commitments and revenues. 

Investors and other stakeholders can better evaluate a company’s financial health and compare performance to competitors by employing these approaches and adhering to GAAP.

related: annual budgeting guide for startups

An accrual basis of accounting, as opposed to a cash basis, provides a more realistic picture of a company’s financial situation. A cash basis provides a picture of current cash status but does not reflect future spending and obligations like an accrual technique. 

Similarly, deferred expenses and revenue are not recognized on a cash basis of accounting. Expenses and income are only recorded when bills are paid or money is received.

The main advantage of accruals and deferrals is that revenue and expense will be aligned, allowing firms to account for all expenses and revenue during an accounting period. 

Businesses would not have an accurate picture of what they owe if they only recorded transactions when revenue was received or payments were made.

This accounting system also tries to even out earnings over time. For example, using the cash technique, an eCommerce company might look enormously profitable during the holiday selling season in the fourth quarter but unprofitable once the holiday rush ends in the first quarter. 

Neither metric reveals the whole story. In cash accounting, revenue is recognized when it is received (during Q4), but expenses for things acquired are not recognized until they are paid for, which may not be until Q1 of the following year. Using the accrual technique, you would account for the expenses incurred in pursuing revenue. 

explore more: tax evasion vs. tax avoidance: definitions, types, and differences 

Countick can help you with any business tax services needed for your startup or growing business. With a team of professionals, Countick is helping many businesses to minimize their bookkeeping mistakes and file taxes on time to avoid penalties.

frequently asked questions related to accruals and deferrals.

Here are some frequently asked questions and answers about accruals and deferrals.

1. what is the primary difference between accrual and deferral accounting?

The primary distinction between accrued and deferred accounting is when revenue or expenses are recorded. An accrual is an accounting transaction that is brought forward and recorded in the current period even though the expense or revenue has not yet been paid or received. A deferral method delays payment until it is made or received.

2. is prepaid insurance a deferral or an accrual?

Prepaid expenses are paid before obtaining the products or services. Prepaying insurance, for example, is often recorded on the balance sheet as a current asset, with the expense postponed. Typically, the amount of the asset is changed monthly by the amount of spending.

3. what is the purpose of accruals?

Accrual is an account adjustment to match revenue and spending appropriately. Whether or not cash has been received, expenses incurred to create income must be reported.

4. what kinds of expenses are often postponed?

Prepaid fees, such as insurance or rent, are frequently deferred. Other deferred expenses include supplies or equipment purchased now but used later, deposits, service contracts, or subscription-based services.

Deferred expenses may also apply to deferred intangible assets owing to amortization or tangible asset depreciation charges.