The words “debit” and “credit” do not mean the same in accounting as they do in general. In fact, they mean the opposite to what you would expect, for example, an unpaid bill can be a credit and increase the balance of an account. Accountants have to record all transactions in balancing accounts. So a credit recorded in one account causes a debit in another. Sometimes these accounts have to be altered slightly to make everything add up, or account for unexpected events. These alterations are debit and credit adjustments.
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The system of recording accounts that is used throughout the world in accounting is called “double-entry bookkeeping.” When bookkeepers note down the transactions in each account, they represent that account with two columns. The left column represents “Debit” and the right column represents “Credit.” The balance of some accounts increase with debit transactions and the balance of others increase with a credit transaction. However, everything the company does has an impact on at least two accounts and the amount added to the debits in one account must be balanced by a credit entry in another account.
Accounts show the state of the company’s finances at the end of each month. However, real life doesn’t compartmentalise so neatly into monthly events. Stock bought in one month gets processed in another, customers pay for goods on receipt of invoice, but the delivery of the goods and use of supplies may have occurred in a previous month. Some things have to be paid for upfront, like a year’s insurance cover, while others are paid later, such as wages.
An accrual is an adjusting entry in the accounts. It occurs when money is due for work performed in one period, but will not arrive until the next period. This is money owed to the company and it will trigger a series of adjusting entries, both credit and debit entries in a number of the accounts. These adjustments do not invent money, but they allot income to the time they were earned and not to the date the payment arrived.
The opposite of accrual is a prepayment. An example of this is the payment for insurance cover. The payment is made out of cash in one month, but the company does not benefit from that insurance cover only for the month in which it was made. Therefore, the accountant makes both credit and debit adjustments in various accounts to spread the cost of insurance to later months, and reduce the impact that advanced payment had on the company’s earnings for the month the payment was made. Again, this is not fraud - it is merely adjusting the accounts to better allocate costs to periods that will receive the benefit of the outlay.
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