Wages, interest, unbilled work — and the cash entry that follows

Cash later

A deferral tidies up cash that has already moved. An accrual records revenue or expense that has been earned or incurred when the cash has not moved yet — and there is no document to trigger it, which is why it is so often missed. The pattern: an expense with a payable, or a revenue with a receivable; and the amount is only the portion elapsed to the year end, never the whole term.

$$\text{Interest}=\text{Principal}\times \text{Rate}\times \text{Time}$$

Time is months ÷ 12 unless the case gives dates, when it is days ÷ 365. Say which in every answer; the convention is a mark.

Worked example — Northlake's four accruals

Wages. Staff worked 28–31 December; the payroll runs 7 January. Four days' wages, 4,700, are a December expense: Dr Salaries Expense 4,700 / Cr Salaries Payable 4,700.

Interest on the note. The $30,000, 6 % note has run since 2 December — one month. $30{,}000 \times 6\% \times \tfrac{1}{12} = 150$. Dr Interest Expense 150 / Cr Interest Payable 150. Not 1,800: that is a full year, and only one month has elapsed. And not a credit to Notes Payable — the principal has not changed; the interest is a separate, new liability.

Interest on the bank loan. The $400,000 loan at 6 % has run since 1 November, with interest paid each 30 April and 31 October — so nothing has been paid for November and December. Two months: $400{,}000 \times 6\% \times \tfrac{2}{12} = 4{,}000$. Dr Interest Expense 4,000 / Cr Interest Payable 4,000.

Grooming for the township. In late December Northlake groomed the township's trails under the December contract — 2,600 of work — and the invoice goes out in January. The revenue is earned: Dr Accounts Receivable 2,600 / Cr Service Revenue 2,600. Waiting for the invoice date pushes December's revenue into January and understates both the receivable and the income.

A revenue accrual from the other side. Pinecrest lent $10,000 to a related company on 1 October at 6 %, interest payable at maturity. Three months have elapsed: $10{,}000 \times 6\% \times \tfrac{3}{12} = 150$. Dr Interest Receivable 150 / Cr Interest Revenue 150. The principal stays in Notes Receivable.

The cash entry that follows

On 7 January Northlake pays a payroll of 11,700, of which 4,700 was accrued at 31 December. The accrued part clears the payable; only the rest is January's expense:

Jan 7   Salaries Payable                  4,700
        Salaries Expense                  7,000
            Cash                                   11,700
        Payroll; 4,700 accrued at 31 December.

Debiting Salaries Expense for the whole 11,700 would count the four December days twice — once in December's accrual and again in January — and leave a 4,700 payable that is never paid. The same logic clears Interest Payable when the interest is paid, and Accounts Receivable when the township pays its invoice: the accrual has already recorded the revenue or expense; the cash entry settles the balance-sheet account.

Days ÷ 365

A $20,000 note at 7 % issued 16 November, year end 31 December. Count the days elapsed, excluding the day of issue: 14 remaining in November + 31 in December = 45 days. $20{,}000 \times 7\% \times \tfrac{45}{365} = 172.60$. State it: "days ÷ 365, excluding the issue date".