Distinguish between deferrals and accruals with examples.

• A. Deferrals are revenues recognized when earned and expenses recognized when incurred; accruals are recognized when cash is exchanged.
• B. Deferrals are cash receipts/payments after revenue or expense recognition; accruals are revenues/expenses recognized after cash is exchanged.
• C. Deferrals are recognition of revenue and expense only after year-end; accruals occur at year-end only.
• D. Deferrals are cash receipts/payments before revenue/expense recognition; accruals are revenues or expenses recognized before cash is exchanged.

Answer: (D)

The distinction rests on timing between cash flow and when revenue or expense is recognized. Deferrals happen when cash moves before recognition, so you’re postponing the actual income or expense to a future period. This creates an asset (like prepaid expense) or a liability (like unearned revenue) that is later reclassified into the proper revenue or expense as time passes or services are performed. For example, paying for a one-year insurance policy up front puts money into a prepaid insurance asset, and you gradually expense it each month as the coverage is used. Similarly, receiving cash before delivering goods or services creates unearned revenue, a liability, which becomes revenue once the service is performed or goods are delivered.

Accruals occur when revenue or expense is recognized before cash changes hands. This means you record an asset or liability to reflect amounts earned or incurred now, with cash flowing later. Examples include earning wages in a period that won’t be paid until a future date (creating wages payable) or performing a service this month that hasn’t been billed yet (creating accounts receivable and recognizing revenue now).

So deferrals delay recognition until after cash flow, while accruals recognize in the current period before cash moves.