In the accounting terms Accruals can play a big part in a company’s accounts. In this article we will explain what accounting accrual is and how to use accruals in our accounting.
What is accounting accrual?
Accruals are an accounting fact that serves to reflect in accounting the operations in the corresponding period, that is, in the exact period where they occur or take effect.
Among the General accounting principles we can find the accrual principle, which refers to the registration of economic transactions when they occur. To be more exact, we can read the Accrual principle below:
“The effects of the transactions or economic events shall be recorded when they occur, imputed to the year to which the annual accounts refer, the expenses and income that affect it, regardless of the date of payment or collection.”
That is, the income and expenses recorded in the accounting must be divided between the accounting periods in which that operation or accounting event actually occurs, assigning to each period the corresponding part of the income or expense.
An example of an operation with accrual would be the purchase of of annual insurance. At the time of contracting, the annual insurance fee is normally paid. Even if a single payment is made, this expense must be distributed among the 12 months in which the insurance is in force. Each month the expense corresponding to that period will be accrued, regardless of when the payment has been made.
When does the accrual of an operation occur?
We understand an expense as accrued when the company receives or enjoys the goods and / or services inherent in that expense. In the income part, we speak of an income accrued when the delivery of the goods and / or services provided occurs.
The delivery or receipt of goods, as well as the enjoyment or provision of services, refers to the actual flow of operations, this is exactly when the events occur, regardless of when they are charged or paid.
When we refer to the moment of collection or payment, we are referring to the monetary flow, which may not be the same as the actual flow.
The main objective of the registration of accruals is to be able to differentiate between the real and the monetary currents.
As we have seen previously with the definition of the accrual principle, in accounting it is not enough to reflect the monetary flow of operations but it is also necessary to record the actual flow.
Types of accounting accruals?
Depending on the difference between the real and the monetary currents, whether one way or the other, we will have different types of accruals :
1. Expenses and / or income whose operations have been carried out during the year (actual current), and which have not yet been paid and / or collected.
2. Payments and / or collections made during the year (monetary current) for which the real current has not yet occurred, that is, the operation or accounting event has not occurred. The account names involved in these types of accruals are:
– Prepaid expenses
– Prepaid income
Accounting examples of accruals
Here are some examples of how accounting entries are recorded with accruals.
1. Expenses and income for which payment has taken place but the cost of the item needs to be spread over a period of time
a) The dentist clinic “Dentwhites Ltd ” has received on December 1 materials from one of its suppliers which will relate to the next 2 months worth £5,000. The payment terms are 30 days…
December 1st charge to materials……………£2,500
January 1st charge to materials…………………£2,500
Bank December 30th…………………………………£5,000
b) The company “Albany Builders Ltd” is carrying out a work in the house of Mr. Martín worth £10,000. The work has started in December but the payment will occur once everything is finished, which is expected to occur 60 days later.
December 1st cost of building work accrued………………………….£5,000
January 1st cost of building work accrued……………………………….£5,000
Bank payment to Albany Builders Ltd January 30th …………….£10,000
2. When the payment has been made in advance of the work or service then it’s recorded as a Prepayment for example:
a) The consulting firm “Martín & Martín SL” has been invoiced for its annual public liability insurance. The insurance is contracted on October 1 and the annual premium amounts to £720 and payment is due immediately.
This would impact on your accounts as £720 coming out of your bank account with immediate effect and with the total amount being processed to Prepayments. Then each month a charge of £60 would be placed against your public liability account code.
You would process the invoice to the supplier account and then make the payment…
October 1st Invoice received from the Insurance company …………………..£720
October 1st payment made to the Insurance company…………………………..£720
October through to September the following year a £60 charge would go against the account for Public Liability Insurance and the amount would steadily reduce in your Prepayment Account.
We hope this article can help you to better understand what accounting accruals are and how to register them in your accounting.