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
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.
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.
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.