Deferrals and accruals, times revenue and expense, plus amortization

Why the books need adjusting

Every entry in Module 4 was triggered by an exchange — cash, a bill, an invoice. At the year end some things have happened with no exchange to trigger an entry: insurance has expired, passes have been skied, the groomer has worn, staff have worked, trails have been groomed and not yet billed. Adjusting entries record those, dated the last day of the period, so that the statements show the period's real revenue, expenses, assets and liabilities.

Every adjusting entry has two properties worth stating before any of them is written: it touches one income-statement account and one balance-sheet account, and it never touches Cash. If a proposed adjustment credits Cash, it is not an adjustment — it is a transaction that was missed.

Worked example — Northlake's five year-end facts

At 31 December Northlake's bookkeeper lists five things that happened with no document to trigger them. Each is one family.

1. A month of the $6,000 insurance policy has expired. Cash moved first (3 December); the expense comes later. A deferral of an expense — the family is prepaid expense used up. Pattern: Dr Insurance Expense / Cr Prepaid Insurance.
2. A month of the $54,000 of season passes has been skied. Cash moved first; the revenue comes later. A deferral of revenue — unearned revenue earned. Pattern: Dr Unearned Revenue / Cr Service Revenue.
3. The groomer and the lodge have worn through two months of their lives. Cash moved first (the asset was bought); the expense comes later, year after year. A deferral too — but so distinctive that Canadian texts count it as its own family: amortization. Pattern: Dr Amortization Expense / Cr Accumulated Amortization.
4. Staff have worked 28–31 December and will be paid 7 January. The expense has been incurred; cash moves later. An accrual — accrued expense. Pattern: Dr Salaries Expense / Cr Salaries Payable. Interest owed on the note and the loan is the same family: Dr Interest Expense / Cr Interest Payable.
5. The township's trails were groomed in late December and the invoice goes out in January. Revenue earned; cash later. An accrual — accrued revenue. Pattern: Dr Accounts Receivable / Cr Service Revenue.

So the taxonomy is a two-by-two — deferral (cash first) or accrual (cash later), times expense or revenue — with amortization as the fifth box, a deferral of a cost that lasts years. The word to own: a deferral defers recognition of cash that has already moved; an accrual accrues revenue or expense ahead of cash that has not.

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