For example a company may do a special review of

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For example, a company may do a special review of potential legal exposures at the end of each fiscal year and set up an estimated accrual to provide for them. Regardless of how it's done,
identifying and recording these types of adjusting entries is an important part of the accounting process that can have a large impact on the financial statements of the business. More on Accruals Another way to look at accruals is to think of them as transactions where cash changes hands after revenue or expense is recognized, and you can think of them as either accruals related to revenue or accruals related to expenses. Accruals related to revenue arise when a company delivers goods or performs a service before receiving payment. We have already seen examples of this when we learned about selling on credit earlier in the course. When Cardullo’s sells gift baskets on credit to Harvard’s Society of Fellows, Cardullo’s immediately records a journal entry recognizing the revenue from the sale and recording the amount in accounts receivable, even though cash will not be received until later. Accounts receivable is the most common example of this type of accrual. Accruals related to expenses arise when a company uses resources before paying for them. We have seen examples of this as well, when we learned about buying on credit earlier in the course. When Bikram Yoga Natick has maintenance performed on the studio’s heating system, Bikram Yoga Natick immediately records a journal entry recognizing the expense and recording the amount in accounts payable, even though cash will not be paid until later. Examples of this type of accrual include interest payable, salaries payable, taxes payable, and utilities payable. Accruals may occur and be recorded throughout the year whenever these kinds of transactions arise, but they are only considered adjusting entries when they are implicit transactions recorded at the end of the period, during the closing process. Thus, neither the accounts receivable in the context of Cardullo’s nor the accounts payable in the context of Bikram Yoga Natick examples above are adjusting entries. At the end of the period, a company will want to ensure that all appropriate accrual entries have been made to accurately reflect the activities related to that period. Let’s look at some examples of accruals and adjusting journal entries. 4..2.2 Deferrals When a business receives payment in advance for a product or service, the business needs to record a liability to represent the obligation to the customer. At the end of a period, the business will make sure that revenue has been recognized for products delivered or services provided. Example - Bikram Yoga Natick. The purchase of an annual membership entitles a customer to 12 months of yoga classes. After receiving the payment, Mary has the obligation to provide those classes. As the classes are provided over time, she will need to adjust the liability down and recognize revenue for the service.

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