Class, here is an overview of accrual accounting. I hope this may help you understand.

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if you have any questions.

ACCRUAL ACCOUNTING Income and Expense are recorded when they are EARNED (for Income)
INCURRED (for Expense), not necessarily when cash is received or paid.
Income is earned when:
Activities necessary to generate revenue substantially complete
Amount of revenue can be objectively determined
Reasonable certainty that amount will be received
Expenses are incurred when:
The expense has been used up/incurred/consumed by the business.

Accrual Accounting for Revenue

Revenue Receivable: Revenue has been earned, but the cash has not yet been received
Example: On December 30, we sold $1000 on credit. Cash was received in January.
In December:
Accounts Receivable Increases 1000
Revenue (Sales) Increases 1000
December Income Statement
Revenue (Sales) 1000
Expenses
XXX
Profit
+1000
December Balance Sheet
Assets Increase (Accounts Receivable) 1000
Owners Equity (Retained Profit) Increases 1000

In January:
Accounts Receivable Decreases 1000
Cash Increases 1000
January Income Statement
NO EFFECT
January Balance Sheet
Assets Increase (Cash) 1000
Assets Decrease (Accounts Receivable) 1000

Unearned Revenue: Cash has been received, but revenue has not been earned.
Example: On December 30, we receive a $1000 cash deposit for work to be completed in January. In
January, we complete the work.
In December:
Cash Increases 1000
Unearned Revenue Increases 1000
December Income Statement
NO EFFECT
December Balance Sheet
Assets Increase (Cash) 1000
Liabilities (Unearned Revenue) Increases 1000
In January:
Liabilities Decrease 1000
Revenue Increases 1000
January Income Statement
Revenue (Sales) 1000
Expenses
XXX
Profit
+1000
January Balance Sheet
Liabilities (Unearned revenue) decrease 1000
Owners Equity (Retained Profit) Increases 1000

Accrual Accounting for Expenses

Accrued Expenses: Goods or services are used, but not yet paid for.
Example: In December we use electricity, but do not receive the electricity bill until January. In
January the bill is paid. (Electricity from January November cost $1,100, therefore, we can estimate
that December electricity will cost about $100).
In December:
Accrued expenses increase 100
Electricity expense Increases 100
December Income Statement
Revenue (Sales) XXXX
Expenses
(100)
Profit
-100
December Balance Sheet

Liabilities Increase (Accrued Expense) 100

Owners Equity (retained profit) decreases 100
In January:
Assets Decrease 100
Liabilities Decrease 100
January Income Statement
NO EFFECT
January Balance Sheet
Assets (Cash) decrease 100
Liabilities decrease (accrued expenses) 100

Prepaid Expenses: Money paid for goods or services in advance, the expense has not yet been
incurred.
Example: On December 30 we pay $100 for Januarys rent.
In December:
Prepaid expenses increase 100
Cash decreases 100
December Income Statement
NO EFFECT
December Balance Sheet
Assets Increase (prepaid expense) 100
Assets decrease (cash) 100
In January:
Expenses Increase 100
Assets Decrease 100
January Income Statement
Revenue (Sales) XXXX
Expenses
(100)
Profit
-100
January Balance Sheet
Assets Decrease (Prepaid Expense) 100
Owners Equity (retained profit) decreases 100