Chapter 3 – Accrual Accounting & Adjusting

Chapter 3 is about the timing of recording revenues and expenses — the “when” of accounting, often referred to as the basis of accounting and adjusting entries.

🔢 1. The Accounting Period

Think of this as the “calendar” for a business — just like school years are broken into semesters, businesses break time into periods:

Monthly (Jan, Feb, etc.)
Quarterly (Q1 = Jan–Mar, etc.)
Annually (Jan–Dec or any 12-month cycle)

📌 Why? So businesses can report income and expenses periodically rather than just at the end.

🧾 2. Accrual Basis vs. Cash Basis Accounting

Accrual Basis (used by most businesses):

Revenue is recorded when earned — even if no cash is received yet
Expenses are recorded when incurred — even if not paid yet

📦 Analogy: You order a pizza and agree to pay later. Under accrual, the pizza shop records the sale now (when they deliver), not when you pay next week.

Cash Basis (simpler, used by small businesses or individuals):

Revenue is recorded only when cash is received
Expenses are recorded only when cash is paid

💵 Analogy: Like your personal budget. You don’t care when your streaming subscription started—you only count it when money leaves your account.

📈 3. Revenue Recognition Principle

Record revenue when the good/service is delivered — not necessarily when cash comes in.
A certain amount must be expected from the customer.

🧠 Think of Amazon: They ship your item and recognize revenue even if you haven’t paid yet (like using a credit card).

💸 4. Expense Recognition Principle (Matching Principle)

Expenses are recorded in the same period as the revenues they help generate.

🔍 Analogy: If you spend $100 on ads in January that lead to $500 of January sales, the ad expense should be recorded in January — not later.

⚙️ 5. Adjustments for Transactions

Adjusting entries ensure the financial statements reflect economic reality, especially when:

Cash is received before or after something is earned or spent
The event spans more than one accounting period

Type	Description	Cash Involved?
Deferral of Expense	Cash is paid before the expense is incurred (e.g., prepaid rent)	✅ Yes
Deferral of Revenue	Cash is received before revenue is earned (e.g., gift card sales)	✅ Yes
Accrued Expense	Expense is incurred before cash is paid (e.g., wages payable)	❌ No
Accrued Revenue	Revenue is earned before cash is received (e.g., accounts receivable)	❌ No

📦 Analogy:
Deferrals = buying groceries for the month in advance.
Accruals = eating dinner now and paying for it later.