There are two types of accounting; Accruals accounting and cash accounting. Cash Accounting records entries when cash is received or spent. It can be easier for businesses to record the transactions, as it is straight from the bank statements. For cash accounting, accruals are not needed.
The benefits of accruals accounting are that the business reports show the company’s actual position in a period. If you are not sure which accounting system is suitable for the business, check with your accountant first for advice.
Accruals Accounting Definition
Accruals Accounting adjusts the accounts to record when the transaction takes place. The transaction takes place when the goods or services are delivered or received.
A simple example of this is a business that uses a consultant for some work. They issued the client the sales invoice but had not received the consultancy invoice in the same period. An accrual is therefore needed to adjust the accounts for the consultancy.
You will need to choose which system you use before setting up the accounts. When you set up accounts software, an option is available for both cash and accruals accounting.
Accruals in the Balance Sheet
As with all double entry bookkeeping, there will be two entries to the accounts. One will be a debit to an expense account, and the balancing item is to the accruals under current liabilities. See the example further down of an accrual journal.
Reverse the journal entry when the transaction appears in the accounts; otherwise, a duplicate amount is in the reports. Accounting software packages have an option to reverse a journal after the month-end automatically. It will save errors with both the accrual and invoice posted to the system.
Here are several different examples:
Utilities – The utility company may only issue a bill once a quarter when they read the meter. It will mean that no transaction will show in the accounts for the period. Therefore the accounts need adjusting.
Goods and services – A supplier delivers products or services but does not invoice until the following month. An adjustment is needed in the accounts to include these items; it might be an estimate.
Wages – You may pay salaries to the 26th of the month, post the additional days of the month using an accrual.
Sales – As a business, you may work on a project for months before issuing the invoice. A sales accrual will post to the accounts. Ensure that you also enter any expenses that relate to the sale as well. It is recorded as an asset in the balance sheet.
Taxes – Taxes incurred by the business and no bill is received from the tax office. An example is that a company has calculated its year-end profits, and corporation tax is due. A journal is therefore required to make the adjustment.
How do Accruals Work?
Accruals work by altering the accounts to move the transaction from one period to another. Post a reversing journal when the correct paperwork is on the system. Using Accounting software, you set the journal up to automatically reverse in the next period.
Accruals Accounting Journal Entry
Below is an example of a journal entry. The entry shows two accruals; the first is for a consultancy invoice not received from the supplier the second is for an electricity adjustment. Once the journal is prepared, post it to the accounts at the month or year-end.
Return from Accruals accounting to Balance Sheet.