Accrual Study Guide

📖 Core Concepts Accrual – an asset (receivable) or liability (payable) for revenue or expense that has been earned/incurred but not yet paid. Accrual Accounting – records revenue when earned and expense when incurred, regardless of cash flow. Cash‑Basis Accounting – records transactions only when cash is received or paid. Matching Principle – expenses are recognized in the same period as the revenues they help generate. Revenue Recognition – revenue appears on the income statement when earned, not when cash is collected. Accrued Revenue (Accrued Asset) – earned income not yet received; appears as revenue on the income statement and as accounts‑receivable on the balance sheet. Accrued Expense – liability for goods/services received but not yet paid; appears as expense on the income statement and as accounts‑payable (or other payable) on the balance sheet. Provisions – liabilities with significant uncertainty about timing or amount; less certain than accruals. --- 📌 Must Remember Accrual vs. Cash: Accrual → timing = when earned/incurred; Cash → timing = when cash moves. Financial‑Statement Impact: Accrued revenue → Income Statement +Revenue, Balance Sheet +Accounts Receivable. Accrued expense → Income Statement +Expense, Balance Sheet +Accounts Payable. Cash Collection/Payment: Does not change the income‑statement amounts; only shifts balance‑sheet accounts (AR ↓, Cash ↑; AP ↓, Cash ↓). Certainty: Accrued expenses are more certain than provisions. Typical Accrued Expenses: Employee vacation pay, other employee benefits. Trade Payables vs. Accruals: Trade payables are invoiced/contracted; accruals are received but not yet invoiced. --- 🔄 Key Processes Recording Accrued Revenue Debit Accounts Receivable; credit Revenue. Collecting Cash on Accrued Revenue Debit Cash; credit Accounts Receivable. (Income‑statement unchanged) Recording Accrued Expense Debit Expense; credit Accounts Payable (or other payable). Paying Cash for Accrued Expense Debit Accounts Payable; credit Cash. (Income‑statement unchanged) --- 🔍 Key Comparisons Accrual Accounting vs. Cash Basis Accrual: Recognizes when earned/incurred. Cash: Recognizes when cash moves. Accrued Expense vs. Trade Payable Accrued Expense: Received, not yet invoiced/paid. Trade Payable: Invoiced or formally agreed upon. Accruals vs. Provisions Accruals: Low uncertainty in amount/timing. Provisions: High uncertainty; estimates required. Accrued Revenue vs. Accrued Expense Revenue: Asset (Accounts Receivable). Expense: Liability (Accounts Payable). --- ⚠️ Common Misunderstandings “Collecting cash changes revenue” – false; revenue was already recognized when earned. “Paying an accrued expense reduces expense” – false; expense stays on the income statement; only the liability shrinks. “All payables are accruals” – false; trade payables are invoiced obligations, while accruals are not yet invoiced. “Provisions and accruals are interchangeable” – false; provisions involve higher estimation uncertainty. --- 🧠 Mental Models / Intuition “Earned ≠ Received” – Picture a delivered pizza: the sale is earned (revenue) even if the customer hasn’t paid yet (cash). “Liability = Service Received, Bill Not Yet Arrived” – Think of a utility bill you already used; you owe money (accrued expense) before the invoice lands. “Matching = Pairing Shoes” – Expenses are the left shoe, revenue the right shoe; they must be recorded together to keep the pair (the period) balanced. --- 🚩 Exceptions & Edge Cases Accrued Interest – interest that has built up but not yet been paid; treated like any other accrued expense. Deferrals – opposite of accruals; revenue or expense is postponed to a later period (e.g., prepaid rent). --- 📍 When to Use Which Choose Accrual Accounting when you need accurate period‑matching (most public companies, GAAP). Use Cash Basis only for very small entities that don’t require GAAP compliance. Record an Accrued Expense when you have received a service/good but have no invoice yet. Record a Provision when the amount or timing of the outflow is uncertain and requires estimation (e.g., lawsuit settlements). --- 👀 Patterns to Recognize Balance‑Sheet Swap: Whenever cash later moves, look for a simultaneous opposite change in AR or AP. Revenue vs. Cash Timing: Questions that mention “earned but not received” → accrue revenue. Expense vs. Invoice Timing: “Service received, invoice pending” → accrue expense. Certainty Cue Words: “Known amount/timing” → accrual; “estimate” or “uncertain” → provision. --- 🗂️ Exam Traps Distractor: “Accrued expense reduces expense when paid.” – Incorrect; expense already recognized. Distractor: “Accrued revenue is a liability.” – Wrong; it is an asset (Accounts Receivable). Distractor: “Trade payable and accrued expense are the same.” – Misleading; trade payables are invoiced, accruals are not. Distractor: “Provisions are more certain than accruals.” – Reversed; accruals are more certain. Distractor: “Cash collection changes the income statement.” – False; only balance‑sheet accounts shift.