Adjusting for what hasn't been paid or billed yet¶
The last section adjusted for cash that already moved: paid before something was used up, collected before work was done. This time the cash hasn't moved at all. Employees work all week before Friday's paycheck. A bank charges interest on a loan every day whether or not anyone sends a payment. A company can finish a job on the last afternoon of the month and not invoice it until next week. In every case, the expense or revenue is already real at period end, even with no cash moved. Skip the adjustment, and the books understate what the company owes or has earned.
Accrued expenses: the cost lands before the cash¶
An accrued expense is a cost the company has already incurred but hasn't paid yet: the mirror image of a prepaid expense. With a prepaid, cash goes out first and the expense follows later, as the asset is used up. With an accrual, the expense happens first and the cash follows later. Since no cash has moved, the credit can't go to Cash; it goes to a liability, because the company now owes someone: Salaries Payable for wages employees have earned but not been paid, Interest Payable for interest piled up on a loan, and Utilities Payable for electricity or gas used before a bill even arrives.
Wages earned since the last payday
Foothill Fitness Coaching pays its one trainer $150 a day. Two days have passed since the last payday, and payday itself isn't for another week.
| Account | Debit | Credit |
|---|---|---|
| Salaries Expense | 300 | |
| Salaries Payable | 300 |
The trainer already earned the $300, so the expense is recorded now. The company owes it, so the credit is a liability, not Cash.
That same logic covers a utility bill that hasn't shown up yet. The gas and electricity were used during the period, so the expense belongs there, not to whenever the invoice arrives. Because no invoice exists yet, the credit goes to Utilities Payable rather than Accounts Payable, which you used back in Chapter 2 for bills a vendor already sent.
Common mistake: an expense isn't recorded until it's paid
Payment date and expense date are different things. An expense is recorded the moment it's incurred, meaning the moment the company gets the benefit, whether that's an employee's labor or a month of electricity. If it's still unpaid at period end, the credit lands on a payable instead of Cash. Waiting to record it until the check goes out would understate expenses, and overstate net income, for the period the cost actually belongs to.
Accrued revenues: earned before it's billed¶
An accrued revenue is revenue the company has already earned but hasn't billed or collected yet: the mirror image of deferred revenue. With deferred revenue, cash comes in first and the revenue follows later, as the work gets done. With an accrual, the work gets done first, and the cash and often the invoice follow later. The most common version is unbilled services: a company finishes a job by period end but hasn't sent the invoice yet. The customer now owes the company money, so that side is Accounts Receivable, the same account you'd use for anything billed on account. The other side is Service Revenue, because the work is genuinely done.
Work finished, invoice not sent yet
Juniper Web Design finishes a $2,000 website by the last day of the month but doesn't send the invoice until the following Monday.
| Account | Debit | Credit |
|---|---|---|
| Accounts Receivable | 2,000 | |
| Service Revenue | 2,000 |
The work is done, so the revenue is earned now, regardless of when the invoice goes out or when the customer pays.
Common mistake: revenue is recorded when the cash comes in
Cash timing and revenue timing are separate questions. Revenue is recorded when it's earned, that is, when the company has done what it promised. Cash collected in advance, before the work is done, sits in Deferred Revenue until it's earned. Work finished but not yet billed or collected is the opposite case: revenue is earned now, and the amount owed becomes Accounts Receivable.
Interest: the one formula you compute by hand¶
Interest is the clearest accrual of all, because it builds up continuously with time, whether anyone writes a check or not. The formula is always the same:
Interest = principal x annual rate x time, where time is the fraction of a year that's elapsed.
A company that borrows money owes Interest Expense and a growing liability, Interest Payable. A company that lends money (by accepting a note from a customer instead of cash) earns Interest Revenue and a growing asset, Interest Receivable. Same formula, opposite accounts.
Working the fraction of a year
Brightline Cleaning signs a $6,000, 8% note payable on October 1. Its books close on December 31, so 3 months have passed. Interest = $6,000 x 8% x (3/12) = $120. The adjusting entry debits Interest Expense $120 and credits Interest Payable $120. Notice the fraction: 3 months is 3/12 of a year, not 3% or $3.
The fraction-of-a-year step is where most errors happen, so always count the whole months between the note's date and the period end first, then divide by 12, before multiplying by the rate.
Common mistake: an adjusting entry pays the interest
An adjusting entry for interest never touches Cash, no matter how tempting that feels. It only records that interest has accrued: an expense (or revenue) and a payable (or receivable). The bank still gets paid separately, later, in cash, and that later payment is its own transaction.
With every prepaid, deferred, accrued, and interest adjustment now on the books, the next step is to line up every account's updated balance in the adjusted trial balance.
Pause and work¶
Start with the full mix of adjusting entries so you can see accrued expenses and accrued revenues sitting alongside the prepaid and deferred adjustments from last section.
Now try one with some of the amounts hidden. The accounts are filled in for you; your job is to compute the dollar amounts for the four accrual entries, salaries, unbilled services, utilities, and interest.
Interest shows up on both sides of a note. Here's a note payable first, worked all the way through.
Same principal, same rate, same six months, but now the company is on the lending side of a note receivable instead. Fill in the accrued interest and the year-end balance; the months elapsed and the full-term interest are given.