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Accounting Examples - Prepaids and Accruals

 

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Prepaid and Accrued Revenue and Expenses

Often in the day-to-day operation of a business, there are instances where revenue is earned but payment is not immediately received. Other times, payment is received up-front for services to be provided in the future. Expenses, too, can be incurred and then later be paid for -- or they can be paid for in advance of receiving good or services. These events require special handling in accounting so revenues and expenses are properly matched for a given period.

Prepayments

Prepaid expenses and unearned revenues are prepayments - money has exchanged hands but the expense or revenue is not recorded yet because the expense has not been incurred or the revenue has not been earned.

Examples:

  • Prepaid Expense - A 6-month insurance policy costing $1,200 paid for up-front. Because something of value is due the company, the expense prepayment is recorded as an asset (debit Prepaid Insurance and credit Cash).

  • Unearned Revenue - A 6-month cleaning service fee of $600 received in advance. Because the company owes something, the unearned revenue is recorded as a liability (debit Cash and credit Unearned Revenue).

Accruals

Accruals occur when an accounting event happens but no money has yet exchanged hands. Accrued expenses are expenses that have been incurred but are not yet paid for. Accrued revenue is a revenue that has been earned but cash has not been received yet.

Examples:

  • Accrued Expense - Assume that an employee is paid a monthly salary on the 5th of each month for the previous month's work; the February 5th payment is for work the employee performed in January. To accurately account for this expense, the salary expense should be accrued at the end of January (debit Salary Expense and credit Salary Payable). When the pay check is cut on February 5th, Salary Payable is debited and cash is credited.

  • Accrued Revenue - When services are completed and revenue has been earned during a period but payment for these services has not been received by the end of the period, the revenue should be accrued. For example, if a cleaning service begins working in the middle of January and bills the client $600 after a month of cleaning (in the middle of February), revenue of $300 has been earned at the end of January and should be accrued (debit Accounts Receivable and credit Revenue).

Accruals and prepaid accounts are kept current by making adjusting entries, generally at the end of the month or year.

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