Accruals: The accrual accounting principle requires that a firm recognize revenue when they are earned and expenses when they are incurred. At times, there is a timing difference between the cash movements and the recognition of revenues or expenses. In such cases accrual entries are required. If cash is transferred at the same time when the revenue or expense is incurred, there is no need for accrual entries. The four types of accrual entries are:
In December, a newspaper company receives $200 from a customer for the next year’s subscription.
Accounting entry on Dec 31st: Cash (asset) ↑$200 and Unearned subscription income (liability) ↑$200
In December, a laundry company provided $300 worth of services to a customer. The payment will be received next month.
Accounting entry on Dec 31st: Revenue (income) ↑$300 and Accounts receivable (asset) ↑$300.
In December, a retail store paid $12,000 as advance rent for the next year.
Accounting entry on Dec 31st: Rent prepaid (asset) ↑$12,000 and Cash (asset) ↓ $12,000
A company owes its employees $1,000 in wages for work performed in the month of December. The wages will be paid on 5th January.
Accounting entry on Dec 31st: Wages (expense) ↑$1,000 and Wages payable (liability) ↑$1,000
Valuation adjustments: Most assets are recorded on the balance sheet at historical cost. However, accounting standards require that certain assets be shown at current market values. The adjustment required to bring the asset value to the current market value is called valuation adjustment. The accounting equation must be kept in balance. So any valuation adjustment must be offset with an equal change to owner’s equity. This is done either through the income statement or through other comprehensive income.
If an asset of $100 falls to $80, then a valuation adjustment of -$20 must be recorded. Also, a loss of $20 must be recorded either on the income statement or in other compressive income.