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Preparing Bu_ine__ Acc_unts Using The Accru_l Account_ng M_th_d

by

Kenton Casimaty

A__rual accounting is pr_paring the business accounts using the accrual _ccounting concept, wh__h i_ one _f the fundam_ntal accounting principl_s. The object_ve b_hind a__rual account_ng i_ _mat_hing_, wh__h _s b_sic_lly ensuring that all r_v_nu__ and _ll ex_enditures are recorded _n th_ accounting per_od to wh_ch th_y rel_te, i.e. t_ the a__ounting peri_d in wh_ch the revenue was e_rned _r the expense incurred. It d_esn_t matter _f th_ revenue wa_n_t a_tuall_ re_eived _n th_ account_ng _eriod, n_r doe_ it matter if the _xp_ns_ w__n_t actually p_id _n th_ a__ounting p_riod, the import_nt th_ng is to ensure the transaction is compl_t_ly and _ccur_tely recorded.

Accrued _x__ns_s and _re_ayments are the mo_t __mm_n accounting adjustments to make sur_ the accounts _dh_r_ to a__rual accounting requ_rements, and the_e adjustments are be_t expla_ned b_ way of an example. Let_s suppose a bus_ness has a D___mb_r accounting period end. In the M_rch _ft_r the accounting _eriod end the bu_ine__ rece_ves a wat_r bill for $300, wh__h c_vers December, Januar_ and February. S_n_e part _f the w_ter b_ll relates to _ur period end the ___ru_l account_ng principles state we n__d to include a proport_on _f the w_t_r bill _n our accounts. If w_ do not have a precise amount the _nl_ wa_ we can qu_ntify the _x__ns_ is to equally apport_on it, therefore _n th_s scenari_ w_ w_ll include a $100 accrued expense ($300 x 1/3) by debiting th_ w_t_r rate_ account in th_ profit _nd loss _ccount and cr_diting the accruals account in the balan_e sheet.

There are many different t_pes _f expenses that will straddle two accounting _eriods, _ll of which _r_ treated _n this way und_r th_ accrual accounting principle_. In additi_n to expenses that str_ddle two account_ng p_riods it i_ n_t uncommon to receive suppli_r purchas_ invoices late. Y_u may make many purch_ses during the per_od t_ the _nd of De_ember, i.e. b_for_ the end of the accounting period, but the supplier m__ not actually issue the _nvo_ce until after the accounting period end. Even th_ugh the _nvo_ces _re received and settled _fter th_ end of th_ accounting period the expen_e still rel_tes t_ the accounting period end and under th_ a__rual acc_unting principles th_ expense n__d_ t_ be r_cord_d in our _ccounting period end. In an_ther _xam_l_ we w_ll assume the same December accounting period _nd, as abov_. The business r_nt_ _ut a property for $12,000 per annum, which i_ paid quarterly in advance _n February, May, Augu_t _nd November. The payment in November covers November, December _nd January, which i_ after _ur accounting _eriod end. To r_cord th_ entire $3,000 payment w_uld not be _n acc_rdance with a__rual account_ng principles _ince th_ expense for J_nu_ry relates to the next _ccounting per_od. In th__ sc_nario we have a pr_paym_nt (i.e. a p_yment _n advan_e) and, under the accrual

accounting

principl_s, we need to

recognise

th__ fact. Th_ am_unt _f the _re_ayment _s $1,000 ($3,000 x 1/3) and is po_ted to the general l_dg_r b_ d_biting th_ prep_yments account on the balance sh__t _nd crediting the r_nt expen_e in th_ _r_fit and l___ a__ount.

Und_r the accrual accounting concepts th_r_ m__ be other types of _match_ng_ adju_tment_ su_h as pr_viding for deferred and accru_d _ncome. Deferred income i_ incom_ relat_ng to the next accounting peri_d but is re_eived _n the current accounting period, _._. the customer pays in _dv_nc_ or u_fr_nt. Under th_ accrual acc_unting prin_iples we need t_ d_bit th_ _ncome acc_unt _n the profit _nd loss account and _red_t the deferred incom_ account in the balance sheet. Accrued income i_ income that r_l_t_s t_ th_ current _eriod that is not rece_ved until the following account_ng period. Under the _ccru_l accounting pr_nc_ples we have to adjust f_r th__ by d_biting the accru_d income a__ount _n the balance sheet and crediting the sales a___unt in the _rofit and loss a__ount.

Once the current accounting _eriod has been finalised and th_ general ledger account_ closed down, th_ _ccru_l account_ng _on_ept requires us to r_v_r__ the adjustments, hence matching them to the _orre_t a__ounting period. All sets of a__ounts and financial _tatement_ _r_ required to be prepared using th_ accrual account_ng conce_t. It do_sn_t m_tt_r whether the accounts are for a s_l_ trad_, a partnership, a limited l__b_l_ty partnership, a limit_d l__b_l_ty compan_ or a publ_c company all statutor_ and published account_ h_v_ t_ be _re__red using accrual accounting. A__ounts that _r_ produced for internal _ur_oses, su_h _s for manag_m_nt reporting, do not have to b_ pr_par_d us_ng accrual accounting but in the real world even int_rnal manag_m_nt accounts that are onl_ go_ng to be used b_ the bus_ness owners ar_ prepared using a__rual accounting principles. Accrual account_ng __ the standardised _nd accepted meth_d _nd that is what all organisations us_. M_ny people f_nd th_ accrual accounting c_ncept difficult t_ grasp at f_r_t, but if y_u take a _tep back and th_nk about _t _ccru_l a__ounting __ logical and _t will soon f_ll in to place.

Pre_aring accounts and fin_nci_l statements using the a__rual accounting concepts _s not difficult, however _t w_ll require a bit of thought. In th_ real world it _s the a__rual_ accounting concept th_t _revent_ accounts and fin_nci_l _t_tement_ being prepared th_ day _ft_r the end _f the a__ounting period. B_for_ the _ccounting period l_dg_r_ c_n be _losed and th_ accounts pr_par_d you need t_ en_ure th_t all invoic_s relating t_ th_ peri_d _nd have been received. Many suppliers take two to three w__k_ to ___ue purchase invoic_s, s_ if the business acquired good_ _nd services close to the year _nd the _urchase invoice w_n_t be received until the m_ddle to th_ end of January, th_r_for_ the l_dg_r_ cannot be cl_sed d_wn unt_l the end of the first month immediatel_ _fter the acc_unting p_riod end.

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