I mean, the four types of accruals in a financial statement are:
- Unearned revenue
- Accrued revenue
- Prepaid expenses
- Accrued expenses
What are accruals? Why does it matter?
Two methods in reporting revenue and expenses are accrual and cash-based methods. In the accrual method, the recognition of revenue and expenses is independent from cash movements. The company will report revenue when it has provided goods or services, even though money has not changed hands. On the expense side, the company will report it when it has received products and services from the supplier, whether it has paid or not.
In contrast, in the cash method, the company recognizes revenue when it has received money from customers. And, he reports expenses when he has paid cash to the supplier.
How do you report the four types of accruals?
Before discussing each of these, let’s review the concept of double-entry. Double-entry accounting requires you to record a transaction on two accounts so that the accounting equation remains balanced. The accounting equation states that:
Assets = Liabilities + Shareholder equity
You must keep the equation balanced. Thus, when assets increase, the liabilities or shareholders’ equity must increase at an equal nominal. Or, another part of the asset decreases at the same nominal.
Next, you also need to understand the relationship between shareholder equity and net profit. The key account that links the two is the retained earnings. Meanwhile, in general, the link between shareholders’ equity and the income statement is presented in the following equation:
Shareholders’ equity = Contributed capital + Beginning retained earnings + Revenue – Expenses – Dividends paid
For further discussion, we will assume contributed capital, beginning retained earnings, and dividends are constant. Thus, changes in revenue and expense will directly change shareholders’ equity.
Unearned revenue or deferred revenue arises when a company has received cash payments before delivering goods or services to consumers. The company is still obliged to provide products or services. Therefore, the company records it as a liability.
The company received a payment of Rp100 on December 15 for the delivery of goods and services on January 31 the following year.
For the December 31 financial statements, the company recorded cash (in the assets section) increased by Rp100 and recorded an equivalent nominal in the unearned revenue account in the liability.
Furthermore, on the January 31 report, the unearned revenue account decreased by Rp100 (liability ↓) because the company had provided goods and services. At the same time, the company also recognized revenue of Rp100 (shareholders’ equity ↑).
Accrued revenue or unbilled revenue arises when the company has provided goods or services but has not received cash payments. In other words, customers owe cash payments to the company. An example of this account is accounts receivable, which appears when a company sells a product or service on credit.
From the selling, the company recorded accrued revenue in the current assets section (assets ↑). The company also reported an increase in revenue (shareholders’ equity ↓).
Furthermore, when the company receives cash payments, this account decreases, and the company’s cash increases.
The company provided services of Rp100 to its customers in March. For these services, the company will receive cash payments in the following month.
On March 31, the company recognized trade receivables (assets ↑) Rp100. In the income statement, the company also recognizes revenue (shareholders’ equity ↑) of Rp100.
Furthermore, on April 30, the company recognized a decrease in trade receivables (assets ↓) of Rp100. And, due to receiving payments, the company’s cash (assets ↑) increased by Rp100. In total, the company’s total asset is unchanged.
Prepaid expenses arise when the company has made cash payments but has not yet received the goods or services from the supplier. The company recognizes prepaid expenses in the asset section. And, because they have paid cash, the company’s cash also decreased to an equivalent nominal.
When it has received goods or services, the company recognizes that cost and prepaid expenses will decrease at an equivalent nominal.
As of March 31, the company paid Rp100 to its suppliers for the goods to be sent the following month (April).
On March 31, the company recorded a decrease in cash (assets ↓) of Rp100. On the other part of the assets, the company also recognizes prepaid expenses (asset ↑) of Rp100. So that, net, the company’s total asset does not change.
Subsequently, on April 30, the company eliminates the prepaid expenses (assets ↓) of Rp100. And, at the same time, the company reports an expense (shareholder equity ↓) of Rp100.
Accrued expenses arise when the company has received goods or services but has not made cash payments. In other words, the company still owes to its suppliers. The company recognizes the accrued expenses on the liability. In the income statement, the company also recognizes an expense.
Furthermore, after paying cash, the company eliminates accrued expenses on the liabilities section. The company also reported a decrease in cash at an equivalent nominal.
The company received Rp100 in services from its suppliers in March. For these services, the company will pay cash in the following month.
On March 31, the company recognized accrued expenses (liabilities ↑) of Rp100. In the income statement, the company also recognized an expense (shareholder equity ↓) of Rp100.
On April 30, the company eliminates the account of accrued expenses (liabilities ↓) Rp100. And, because it has paid, the company’s cash (assets ↓) at an equivalent nominal.