Accruals are adjustments for 1) revenues that have been earned but are not yet recorded in the accounts, and 2) expenses that have been incurred but are not yet recorded in the accounts. The accruals need to be added via adjusting entries so that the financial statements report these amounts.
An example of an accrual for revenue involves your electric utility company. The utility used coal and many employees in December to generate electricity that customers received in December. However, the utility doesn't bill the electric customers for the December electricity until the meters are read in January. To have the proper amounts on the utility's financial statements, there needs to be an adjusting entry to increase revenues that were earned in December and the receivables that the utility has a right to as of December 31.
An example of an accrual involving an expense is an employee's bonus that was earned in 2012, but will not be paid until 2013. The 2012 financial statements need to reflect the bonus expense and the bonus liability. Therefore, prior to issuing the 2012 financial statements an adjusting entry is prepared to record this accrual.
A T-account is a visual aid used to depict an account in a general ledger. Above the top portion of the T would be the account title. On the left-side of the base of the T would be any debit amounts; on the right-side would be the credit amounts.
The T-account can be helpful in determining the proper balance for an account or to determine the amount to be entered in order to arrive at a desired balance. I always use two (or more) T-accounts when determining how to adjust an account balance. Drawing two T-accounts reminds us that every transaction or adjustment will have to involve at least two accounts because of double-entry accounting.
A common use of T-accounts is in preparing adjusting entries (accruals and deferrals). I begin by drawing two T-accounts. Next, I note that one of the T-accounts will affect a balance sheet account. The other T-account is noted as affecting an income statement account.
As a young accountant I had to determine the effect of a new FASB standard on my employer's financial statements. I reported on the impact on the company's expenses in great detail. I thought I was done until the controller drew two T-accounts on a piece of paper and said, "What about the other account? You told me about the expense account, but what other account or accounts are affected. You know we have double-entry accounting!"
You might get in the habit of using two T-accounts each time you attempt to determine the proper accounting entry. It will help you see the proper amounts and the proper accounts.
An accrual occurs before a payment or receipt. A deferral occurs after a payment or receipt. There are accruals for expenses and for revenues. There are deferrals for expenses and for revenues.
An accrual of an expense refers to the reporting of an expense and the related liability in the period in which they occur, and that period is prior to the period in which the payment is made. An example of an accrual for an expense is the electricity that is used in December, but the payment will not be made until January.
An accrual of revenues refers to the reporting of revenues and the related receivables in the period in which they are earned, and that period is prior to the period of the cash receipt. An example of the accrual of revenues is the interest earned in December on an investment in a government bond, but the interest will not be received until January.
A deferral of an expense refers to a payment that was made in one period, but will be reported as an expense in a later period. An example is the payment in December for the six-month insurance premium that will be reported as an expense in the months of January through June.
A deferral of revenues refers to receipts in one accounting period, but they will be earned in future accounting periods. For example, the insurance company has a cash receipt in December for a six-month insurance premium. However, the insurance company will report this as part of its revenues in January through June.