Accrual vs Deferral Adjusting Entries: When to Use Each
A focused comparison of the two big categories of adjusting entries: accruals (expenses or revenues recognized BEFORE cash) and deferrals (cash received or paid BEFORE recognition). Covers the timing logic, the four sub-types, journal entries for each, and a worked example showing all four sub-types in parallel.
A focused comparison of the two big categories of adjusting entries: accruals (expenses or revenues recognized BEFORE cash) and deferrals (cash received or paid BEFORE recognition). Covers the timing logic, the four sub-types, journal entries for each, and a worked example showing all four sub-types in parallel.
Learning Objectives
- ✓Distinguish accrual from deferral timing logic
- ✓Identify the four sub-types: accrued expense, accrued revenue, prepaid expense, unearned revenue
- ✓Write correct journal entries for each sub-type
- ✓Recognize which sub-type applies to a given transaction
- ✓Walk through a worked example showing all four in parallel
1. The Core Timing Distinction
Accruals and deferrals are the two big categories of adjusting entries. The distinction is timing — specifically, whether cash precedes or follows the recognition event. Accrual: Recognition comes BEFORE cash. The company has earned revenue or incurred an expense, but cash has not yet been exchanged. An adjusting entry is needed at period-end to record the earned revenue or incurred expense and the corresponding receivable or payable. Deferral: Cash comes BEFORE recognition. The company has received cash for services not yet provided, or paid cash for services not yet consumed. An adjusting entry is needed at period-end to recognize the portion that has now been earned or consumed, with the corresponding reduction of the liability or asset. The accrual/deferral framework is the bedrock of accrual accounting. Cash basis ignores both — you record only when cash moves. Accrual basis uses both because the matching principle requires expenses to be recognized in the same period as the related revenue, and the revenue recognition principle requires revenue to be recognized when earned, not when cash arrives.
Key Points
- •Accrual: recognition BEFORE cash exchange
- •Deferral: cash exchange BEFORE recognition
- •Both are needed under accrual accounting
- •Cash basis ignores accruals and deferrals entirely
- •Matching principle and revenue recognition principle drive the need
2. The Four Sub-Types
Each timing category (accrual, deferral) has both a revenue and an expense variant, producing four sub-types total. Accrued Expense. An expense incurred but not yet paid. Example: a company uses electricity in December but receives the bill in January. The expense belongs to December (when the electricity was used), not January (when the bill arrives). Adjusting entry at December 31: Utilities Expense debit; Accrued Liabilities credit. When the bill is paid in January: Accrued Liabilities debit; Cash credit. Accrued Revenue. Revenue earned but not yet billed or received. Example: a consulting firm performs services in December but does not invoice the client until January. Revenue belongs to December. Adjusting entry at December 31: Accounts Receivable debit; Service Revenue credit. When the invoice is collected: Cash debit; Accounts Receivable credit. Prepaid Expense (Deferred Expense). Cash paid for an expense not yet incurred. Example: a company prepays $12,000 of rent on January 1 for the full year. The cash payment in January creates a $12,000 prepaid asset; expense is recognized monthly. Initial entry January 1: Prepaid Rent debit $12,000; Cash credit $12,000. Adjusting entry each month-end: Rent Expense debit $1,000; Prepaid Rent credit $1,000. Unearned Revenue (Deferred Revenue). Cash received for revenue not yet earned. Example: a customer prepays for a one-year SaaS subscription. The cash receipt creates a liability (unearned revenue); revenue is recognized monthly as service is delivered. Initial entry on receipt: Cash debit; Unearned Revenue credit (liability). Adjusting entry each month: Unearned Revenue debit; Service Revenue credit.
Key Points
- •Accrued Expense: incurred but not paid (Expense DR / Liability CR)
- •Accrued Revenue: earned but not billed (Receivable DR / Revenue CR)
- •Prepaid Expense: cash paid, not yet incurred (Asset DR / Cash CR initially; Expense DR / Asset CR over time)
- •Unearned Revenue: cash received, not yet earned (Cash DR / Liability CR initially; Liability DR / Revenue CR over time)
- •Each sub-type has an initial entry and one or more adjusting entries
3. Accrual vs Deferral Comparison Table
The four sub-types arranged by timing and direction. | Category | Cash Timing | Initial Entry | Adjusting Entry | |---|---|---|---| | Accrued Expense | Cash AFTER | None (no transaction yet) | Expense DR; Liability CR | | Accrued Revenue | Cash AFTER | None (no transaction yet) | Receivable DR; Revenue CR | | Prepaid Expense | Cash BEFORE | Asset DR; Cash CR | Expense DR; Asset CR | | Unearned Revenue | Cash BEFORE | Cash DR; Liability CR | Liability DR; Revenue CR | Notice the symmetry. Accrued items have no initial entry because no transaction has yet occurred — the adjusting entry creates the asset (receivable) or liability (payable). Deferred items have an initial entry recording the cash exchange, then an adjusting entry reclassifying the amount as period-end recognition warrants. The direction of the adjusting entry also flips. For accruals, you build the balance sheet account (Liability or Receivable) up. For deferrals, you draw the balance sheet account (Asset or Liability) down as recognition occurs.
Key Points
- •Accrued items: no initial entry; adjusting entry builds the BS account
- •Deferred items: initial entry recording cash; adjusting entry reduces the BS account
- •Accrued expense vs accrued revenue: same logic, opposite direction
- •Prepaid expense vs unearned revenue: same logic, opposite direction
- •Symmetry helps memorization
4. Parallel Worked Example: All Four Sub-Types
Acme Corp at December 31, 2025. Four scenarios occur in parallel. (1) Accrued Expense. Employees worked the final week of December 2025 but will not be paid until January 5, 2026. Weekly payroll is $20,000. Adjusting entry December 31, 2025: Wages Expense $20,000 debit; Wages Payable $20,000 credit. Payment in January 2026: Wages Payable $20,000 debit; Cash $20,000 credit. (2) Accrued Revenue. The company provided $15,000 of consulting services in December 2025 but will not invoice the client until January. Adjusting entry December 31, 2025: Accounts Receivable $15,000 debit; Service Revenue $15,000 credit. Invoice collection in January 2026: Cash $15,000 debit; Accounts Receivable $15,000 credit. (3) Prepaid Expense. On October 1, 2025, the company paid $12,000 for six months of insurance coverage (October through March 2026). Initial entry October 1: Prepaid Insurance $12,000 debit; Cash $12,000 credit. Adjusting entry December 31, 2025: Insurance Expense $6,000 debit (3 months consumed: Oct, Nov, Dec); Prepaid Insurance $6,000 credit. Remaining $6,000 stays as prepaid asset. (4) Unearned Revenue. On November 1, 2025, a customer prepaid $9,000 for a six-month service contract (November through April 2026). Initial entry November 1: Cash $9,000 debit; Unearned Revenue $9,000 credit. Adjusting entry December 31, 2025: Unearned Revenue $3,000 debit (2 months earned: Nov, Dec); Service Revenue $3,000 credit. Remaining $6,000 stays as unearned revenue liability. December 31, 2025 income statement effect: +$15,000 revenue (accrued); +$3,000 revenue (unearned recognized); −$20,000 wages expense (accrued); −$6,000 insurance expense (prepaid recognized). Net effect on December 2025 net income: −$8,000. December 31, 2025 balance sheet effect: +$15,000 AR; +$20,000 Wages Payable; $6,000 Prepaid Insurance remaining; $6,000 Unearned Revenue remaining.
Key Points
- •All four sub-types can occur in parallel in a single period
- •Accrued expense: build payable; accrued revenue: build receivable
- •Prepaid: draw down asset; unearned: draw down liability
- •Worked example shows simultaneous adjustments at year-end
- •Net income effect depends on which sub-types dominate
5. How AccountingIQ Helps With Adjusting Entries
Snap a photo of any trial balance and AccountingIQ identifies which accounts likely need adjusting entries (e.g., prepaid balances that should partially expense, unearned revenue balances that should partially recognize, missing accrued liabilities). For CPA FAR exam prep, the app produces practice problems at all four sub-type categories with full journal entry solutions. AccountingIQ also walks through the post-adjusting trial balance to verify the books balance. This content is for educational purposes only and does not constitute accounting advice.
Key Points
- •Identifies likely adjusting entries from trial balance
- •Generates journal entries for all four sub-types
- •Produces post-adjusting trial balance for verification
- •CPA FAR practice mode for each sub-type
- •Works from photographed trial balance or transaction list
High-Yield Facts
- ★Accrual = recognition BEFORE cash
- ★Deferral = cash BEFORE recognition
- ★Four sub-types: Accrued Expense, Accrued Revenue, Prepaid Expense, Unearned Revenue
- ★Accrued Expense: Expense DR / Liability CR (no initial entry)
- ★Accrued Revenue: Receivable DR / Revenue CR (no initial entry)
- ★Prepaid Expense initial: Asset DR / Cash CR; adjusting: Expense DR / Asset CR
- ★Unearned Revenue initial: Cash DR / Liability CR; adjusting: Liability DR / Revenue CR
- ★Cash basis accounting ignores both accruals and deferrals
- ★Matching principle drives need for accruals on expense side
- ★Revenue recognition principle drives need for accruals on revenue side
- ★Period-end adjustments are required before producing financial statements
- ★Closing entries follow adjusting entries to zero out income statement accounts
Practice Questions
1. A company pays $24,000 of rent on January 1 for one year of office space. Write the initial entry and the December 31 adjusting entry.
2. A customer prepays $6,000 on July 1 for a six-month service contract (July through December). What is the December 31 balance of unearned revenue?
3. Employees earned $8,000 of wages in the last three days of December 2025 but will not be paid until January 4, 2026. What is the December 31 adjusting entry?
4. A consulting firm provides $25,000 of services in December 2025 but does not invoice the client until January 2026. What is the December 31 adjusting entry?
5. What is the difference between a "deferred expense" and a "prepaid expense"?
FAQs
Common questions about this topic
Because the matching principle (expenses match the revenues they help generate) and the revenue recognition principle (revenue is recognized when earned, not when cash is received) require timing-based recognition that differs from cash flow. Without adjusting entries, the income statement would not reflect actual performance for the period. A company that prepaid $12,000 of rent on January 1 would show $12,000 of January rent expense — distorting January and zeroing the rest of the year. Adjustments produce period-accurate financial statements.
Almost always at period-end (month-end, quarter-end, or year-end). Companies do not make adjusting entries continuously during the period. They wait until period-end, identify what needs adjustment, and post all adjusting entries together as part of the closing process. The sequence: (1) trial balance, (2) adjusting entries, (3) adjusted trial balance, (4) financial statements, (5) closing entries.
Yes. Prepaid expenses are a clear example: the initial entry records the cash payment as an asset, then each subsequent period-end requires an adjusting entry to recognize the consumed portion as expense. A 12-month insurance prepayment requires one initial entry and 12 monthly adjusting entries (if monthly statements are prepared) or one year-end adjustment (if only annual statements). The same logic applies to unearned revenue, depreciation, and amortization.
No, though both are liabilities. Accounts Payable typically refers to specific amounts owed to vendors based on invoices received. Accrued Liabilities or Accrued Expenses refer to amounts estimated and recorded at period-end before an invoice is received — utilities, wages earned but not yet paid, interest accrued on debt, taxes accrued, etc. AP is invoice-driven; accrued liabilities are accrual-adjustment-driven.
Reversing entries are optional bookkeeping entries made at the beginning of the next period to reverse certain adjusting entries from the prior period. They simplify subsequent transaction recording. For example, an accrued expense adjusting entry on December 31 (Wages Expense $20,000 DR; Wages Payable $20,000 CR) can be reversed on January 1 (Wages Payable $20,000 DR; Wages Expense $20,000 CR). When the actual payment is made on January 5, the routine entry (Wages Expense DR; Cash CR) does not require manual splitting. Reversing entries are a workflow convenience, not required by GAAP.
Snap a photo of any trial balance and AccountingIQ identifies which accounts likely need adjusting entries based on typical patterns (prepaid balances that should partially expense, unearned revenue that should partially recognize). For CPA FAR practice, the app produces problems at all four sub-types with full journal entry solutions and the resulting adjusted trial balance. AccountingIQ also flags common errors like reversing the direction of an adjusting entry. This content is for educational purposes only and does not constitute accounting advice.