Business, Legal & Accounting Glossary
The accruals process allows a business to adjust the monthly accounts for payments made in arrears. This process is the reverse of prepayments.
The accumulation or increase of something over time, especially payments or benefits.
Accrual (accumulation) of something is, in finance, the adding together of interest or different investments over a period of time.
There are certain expenses that are paid quite some time after they have been used. Electricity is a good example. Whilst you are using electricity the cost is accruing. If the business does not account for these costs in the correct accounting periods that the expense is incurred then the account would be inaccurate.
In most cases, the electricity bill is sent every three months. If your business receives an electricity bill in April for electricity it has used in January to March and it has not been accounted for in the accounts, the accounts for January to March will be inaccurate.
The profit in each of these months would have been overstated. To account for this correctly, the business would set up an Accruals account, which is a liability account – this is money that the business owes but has not yet paid.
Most businesses know from experience how much the quarterly electricity bill is likely to be. In view of this, a 1/3 of that quarterly electricity bill is allocated to the electricity expenses account for each month. The transactions would be a debit to the electricity account and a credit to the accruals account each month.
The profit and loss report will show an expense for electricity costs and the balance sheet will show an accruals balance as a liability. This will increase each month until the electricity bill is received.
Once the bill has been received there is no longer a liability, therefore the accrual can be reversed. To do this you would then debit the accruals account and credit the electricity account equal to the amount of the accrual, in order to clear down (reset to zero) the balance. Then finally, the actual amount for the electricity bill would be paid by a debit to the electricity account and a credit to the bank account.
As applied to accounting, accrual describes the concept (known as accrual accounting) where a revenue/expense is not recorded (recognized) at the same moment in time as the related cash inflow/outflow.
For example, on December 30, 2001, a company delivers a product to a customer who will pay for that product 30 days later. Assuming the fiscal year ends on December 31, the company discloses that revenue in 2001 Income Statement even though it will get paid during the following fiscal year.
Similarly, the sales representative that sold the product is entitled to his or her commission at the moment of sale (or delivery). That means the company will record an expense (Salesperson’s Salaries and Commissions) in its 2001 Income Statement, even though the rep will actually get paid at the end of the following week, in January 2002.
Unfortunately, the term accrual is also often used as an abbreviation for the terms accrued expense or accrued revenue, items which may share a common name but have a different economic / accounting characteristic.
Accrued revenue is a receivable for other revenue. It is disclosed separately on the balance sheet primarily to allow investors to differentiate receivables from core operations from receivables from peripheral operations.
An accrued expense, on the other hand, is a liability with an uncertain timing or amount but where the uncertainly is not significant enough to qualify it as a provision.
“11 Provisions can be distinguished from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. By contrast:
“(b) accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.
“Accruals are often reported as part of trade and other payables, whereas provisions are reported separately.”
To add to the confusion, some legalistic accounting systems take a simplistic view of “’accrued revenue”’ and “’accrued expenses”’, defining each as revenue/expense that has not been formally invoiced. This is primarily due to tax considerations, since the act of issuing an invoice creates, in some countries, taxable revenue, even if the customer does not ultimately pay and the related receivable becomes uncollectible.
In payroll, a common benefit that an employer will provide for employees is a vacation or sick accrual. This means that as time passes, an employee accumulates additional sick or vacation time and this time is placed into a bank. Once the time is accumulated, the employer or the employer’s payroll provider will track the amount of time used for sick or vacation.
For most employers, a time-off policy is published and followed with regard to benefit accruals. These guidelines ensure that all employees are treated fairly with regard to the distribution and use of sick and vacation time.
Within these guidelines, the rate at which the employee will accumulate the vacation or sick time is often determined by length of service (the amount of time the employee has worked for the employer).
In many cases, these guidelines indicate there is a trial period (usually 30 to 90 days) where no time is awarded to the employee. This does not prevent an employee from calling in sick immediately after being hired, but it does mean that they will not get paid for this time off. However, it does prevent an employee, for example, scheduling a vacation for the second week of work. After this trial period, the award of time may begin or it may be retrospective, back to the date of hire.
Some accrual policies have the ability to carry over or roll over some or all unused time that has been accrued into the next year. If the accrual policy does not have any type of rollover, any accrued time that is in the bank is usually lost at the end of the employer’s calendar year.
Discuss the main reasons why typical accrual accounting methodologies are not suitable for future decision making.
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This glossary post was last updated: 18th April, 2020 | 8 Views.