Tag Archives | accrual based accounting

Deferrals Definition

See Also:
Deferred Income Tax
Accrual Based Accounting
Accounting Principles
Generally Accepted Accounting Principles (GAAP)
Financial Accounting Standards Board (FASB)

Deferrals Definition

A deferral is used in accrual based accounting when an asset or liability has not been realized. It is recognized however because it will be recognized at a future date. Often times, a deferral refers to a revenue or expense.

Deferrals Meaning

There are generally two types of deferrals in accounting.

The first, deferred revenue, is considered a liability because usually a service needs to be performed or a product must be delivered before the amount can be realized. This would happen if a customer paid for a product upfront with the guarantee that the company will deliver in the future.

The second is a deferred expense. It is often considered a liability because it is considered cash in the company’s pocket that does not have to be paid yet. Often times this extra cash can be put into short term securities to earn extra for the company. The most common deferred expense though are deferred taxes. This is an amount owed to the IRS, but not for a while. Therefore the company can earn extra cash from interest until they need to pay the amount. The money-generating ability of these deferred expenses is what makes them a liability on the balance sheet.

Deferral Example

King Company is in the business of producing toy crowns. In mid-April, King Company received payment from one of its many toy retailer customers. King has set up a plan with its vendors to pay them on a quarterly basis for plastic and other materials. Therefore, King has decided to invest the amount in short term securities until the payment to its vendors comes due at the end of June. Thanks to the lag time in deferrals King company is able to make an extra almost free profit based off of interest rates for two and a half months before its payment at the end of June.

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Accrual Based Accounting GAAP Rules

See Also:
Accrual Based Accounting

Accrual Based Accounting GAAP Rules

Revenue Recognition Principle — GAAP

The revenue recognition principle states that revenue is recognized when earned. In other words, collect the money for services rendered. Revenue is considered earned when the company has fulfilled its obligation to the customer. For example, if a customer orders a product from a company, the company can record the sale once it has delivered that product to the customer, even if the customer has not yet paid. Here, accruals have occurred which leave accounts receivable to be collected.

Revenue Recognition Example

Revenue Recognition remains one of the prime facets of Accrual Based accounting. Therefore, an example is provided below in order to fully understand how the system works.

For example, local laundry contracting company, Buildcorp, makes a profit by designing and building custom houses for customers. A potential buyer contacts an associate with certain specifications for a custom-made house. In most instances, upfront money has to be exchanged between Buildcorp and the buyer. However, sometimes money is not exchanged until the deal is done. Regardless of when the money changes hands, the Buildcorp company accountants cannot recognize the revenue in the accounting records until the house is finished. The completion of the house marks the end of services rendered. This means that the revenue has been earned and can be recorded.

Matching Principle – GAAP

The matching principle states to recognize expenses in the period incurred. For example, a company will recognize employee wages as an expense during the period when those wages are earned, even though the employees don’t actually get paid until the next period. Essentially, the matching principle follows the guidelines of accrual based accounting. The Revenue Recognition Principle requires companies to recognize revenue when earned in its entirety. Much like the revenue recognition principle, the matching principle takes a similar stance on expenses.

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accrual based accounting Gaap rules, Revenue Recognition

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Accrual Based Accounting

See Also:
Accrual Based Accounting GAAP Rules
Time Saving Tip for Filing Accounts Payable Invoices
Statement of Financial Accounting Standards – SFAS
Generally Accepted Accounting Principles (GAAP)
General Ledger Reconciliation and Analysis
Deferrals
Cash Basis vs Accrual Basis Accounting

Accrual Based Accounting Definition

The accrual based accounting definition, or accrual basis accounting, forms a method of recording financial transactions based on economic impact. In the accrual accounting method, record revenues when earned. Then, record costs when incurred, whether or not cash has actually been exchanged between the relevant parties. Contrast this method with cash basis accounting, which records transactions only when cash has been exchanged between the relevant parties. The accounting world uses the accruals concept well, in the accounting world it is far more common to use accrual accounting rather than cash accounting. The accrual definition may also vary based on industry and business model.


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Cash Basis Accounting Method

Cash basis accounting is a method of recording financial transactions which records transactions only when cash has been exchanged between parties. This contrasts with accrual basis accounting, which records transactions based on economic impact. When thinking about accrual vs cash accounting, remember that accrual keeps record of any sales where cash keeps record of income only. It is also possible to perform accrual to cash adjustments and conversions in accounting records.

Cash vs Accrual Basis

When a company sells its product to a customer, it must record the transaction. Using cash basis accounting, the company would not record the revenue from the sale until it received the cash from the customer. Using the accrual method of accounting, the company would record the revenue from the sale once the customer has received the product, whether or not the company has received the cash from the customer. The accrual method seeks to record the entire process of a transaction.

Accrual basis accounting gives a more accurate depiction of a company’s financial condition. However, implementing it is more complicated and more costly than cash basis accounting. Accrual accounting is often used in situations with complexities beyond that of the simple sole proprietorship.

All companies that report financial statements according to GAAP rules use accrual accounting. Only very small and unsophisticated businesses (a local coffee shop, an antique store with little inventory, etc.) would use cash basis accounting.

Accrual Principle

Derive accrual basis accounting on two fundamental accounting principles: the revenue recognition principle and the matching principle.

Accrual Basis Statements

According to GAAP, and in accordance with the revenue recognition principle and the matching principle, you must prepare all financial statements using accrual accounting.

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accrual based accounting

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