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Preparing Business A__ounts Us_ng The A__rual Acc_unting M_thod

by

Kenton Casimaty

Accrual accounting is pr_paring the bus_n_ss accounts using th_ accrual acc_unting concept, which __ one _f the fundamental accounting principle_. The objective behind ___ru_l account_ng _s _matching_, wh_ch _s basically ensuring that all revenues _nd _ll ex_enditures are recorded in th_ accounting per_od to wh__h they rel_te, i.e. to the accounting peri_d in which the revenue was e_rned _r the expense incurred. It d__sn_t matter _f th_ revenue w__n_t actuall_ r_c__v_d _n the _ccounting peri_d, n_r doe_ it m_tter if the ex_ense w_sn_t actuall_ p_id _n the accounting p_riod, the _mportant th_ng __ to ensure the transaction __ _ompletely _nd accurat_ly recorded.

Accrued _x__ns_s _nd prepayments are th_ most common accounting

adjustments

to make _ure the accounts adh_r_ to accrual accounting requirements, _nd the_e adjustments are b_st ex_lained by way of an _xampl_. Let_s suppose a business has a D___mb_r accounting period end. In the Mar_h _ft_r the acc_unting _eriod end the business receive_ a wat_r bill for $300, which _overs December, January and February. Sin_e part _f th_ w_ter b_ll relates to our period end the accrual _ccounting principle_ state we need to include a proport_on _f the water bill in our accounts. If we do not hav_ a precise amount th_ _nly w__ we can quant_fy th_ _xp_ns_ is to equall_ apportion it, therefore in th__ s_enario w_ will include a $100 accrued expense ($300 x 1/3) b_ debiting th_ w_ter rate_ account in th_ profit _nd lo__ account and _rediting th_ a__rual_ account in th_ balan__ sheet.

Th_r_ are m_n_ different ty_es _f ex_en_e_ that will straddle tw_ accounting period_, _ll of which _r_ tr_at_d in this w_y und_r the accrual _ccounting principles. In _dd_t_on to expen_e_ th_t straddle two acc_unting periods _t is n_t uncommon t_ receive su__lier purch_se invoices l_t_. Y_u may m_k_ many purchas_s during th_ _eriod t_ th_ end _f December, i.e. b_f_r_ the end of the accounting period, but the supplier ma_ not actuall_ issue the invoi_e unt_l after the accounting period end. Even though the inv_ices ar_ received and settled _fter the end _f th_ accounting period the expen_e _till r_lat_s to the accounting _eriod end and under the accrual a__ounting pr_nc_ples th_ expen_e needs t_ be r_cord_d in _ur accounting per_od end. In another exam_le we w_ll assume the same December accounting per_od _nd, as ab_ve. The business rents _ut a property for $12,000 per annum, which is paid quarterly _n advanc_ _n F_bruary, May, August and N_v_mb_r. The _ayment _n November cover_ November, D_c_mb_r _nd Januar_, which __ after _ur accounting period end. T_ r_cord the entire $3,000 payment would not be _n accordance w_th ___ru_l a__ounting principles sinc_ the expense for January relates to th_ next account_ng _eriod. In thi_ s_enario w_ hav_ a pr_paym_nt (i.e. a payment _n _dv_nc_) _nd, under the a__rual accounting _rinci_les, we need to recognise th__ f_ct. The am_unt of th_ pr_paym_nt is $1,000 ($3,000 x 1/3) _nd is _osted to the general ledger b_ d_b_t_ng th_ _re_ayments account on th_ balance _heet _nd crediting the rent _xp_ns_ in th_ _r_fit and loss _cc_unt.

Under the accrual _ccounting _on_epts th_r_ ma_ b_ other types _f _matching_ _djustments _u_h as prov_d_ng f_r d_f_rr_d and a__ru_d incom_. Deferred income _s _ncome relat_ng t_ the next accounting peri_d but is rece_ved in th_ current accounting period, i._. the cust_mer pay_ in advance or u_fr_nt. Under th_ ___ru_l a__ounting principles we need t_ deb_t th_ inc_me acc_unt in the _r_fit _nd l_ss _cc_unt _nd cred_t the deferred income acc_unt _n th_ balance sheet. Accrued income __ inc_me that r_l_t_s to the current peri_d that is not re_eived until the following accounting period. Under the a__rual accounting pr_nc_ples we have to _djust for this by d_b_t_ng the a__ru_d income acc_unt in the balance _heet and crediting the sales account in th_ pr_fit and loss account.

Once the current accounting peri_d has been finalised and th_ general ledger account_ closed down, th_ ___ru_l a__ounting conce_t requires u_ to reverse the adjustments, hen_e mat_hing them to the c_rr_ct accounting period. All sets of account_ and financial _t_tement_ are required t_ b_ prepared using th_ accrual account_ng _on_ept. It d__sn_t m_tter whether the accounts are f_r a sole tr_d_, a partnership, a limited liability partnership, a l_m_t_d l__b_l_ty com_any or a public comp_ny _ll statutory and published _ccounts h_ve t_ be _re__red using accrual accounting. A__ounts th_t _re produced for internal purpos_s, su_h __ for management reporting, do not have to be _re_ared using accrual accounting but in the real world even int_rnal management account_ that are only g__ng to b_ used b_ th_ bus_ness owners _r_ prepared using ___ru_l acc_unting principles. Accru_l a__ounting i_ the standardised and accepted m_th_d and that is wh_t all organisations us_. M_ny people f_nd the _ccru_l accounting concept d_ff_cult t_ gra__ at fir_t, but _f you take a st__ back and th_nk about it ___ru_l _ccounting _s log_cal _nd it will soon f_ll in to pl_ce.

Pre_aring accounts and f_n_nc__l statements using the ___ru_l accounting concepts i_ not difficult, however _t will require a bit of th_ught. In the real world it __ the accruals accounting _on_ept that prevents accounts and f_nanc_al statements being prepared th_ da_ aft_r the _nd of th_ acc_unting period. Before the account_ng period ledgers _an be clos_d and th_ accounts pr_p_r_d you need to en_ure that _ll invoice_ relating to the per_od end have been received. Many suppliers take tw_ t_ three weeks t_ issu_ purch_se invoic_s, s_ _f the business acquir_d g__ds and services close to th_ year _nd the purchase inv_ice w_n_t be received until th_ middle to th_ end of January, th_r_f_r_ the ledger_ cannot b_ cl_sed d_wn until the end _f the first month immediatel_ _fter the acc_unting peri_d end.

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