How to post accruals
Accruals directly impact the balance sheet and income statement of any business, including online retailers and eCommerce companies. Recording revenue earned after a credit extension on behalf of a client cannot simply be provided by documenting cash transactions. Essentially, accruals come in handy as they provide information about business activities taken by the company at the end of each accounting period.
By recording accruals, a company can measure and understand its business activities and keep track of its future cash flow. In addition, the business can register its intangible assets, such as copyrights or goodwill, as they have no monetary value. Understanding how to post accruals will ensure your financial record is well-managed to promote the growth of your business.
What are accruals?
In accounting, the accruals basis is a method that allows a company to record revenues before receiving payment for goods or services offered. For example, a utility company provides its services and then bills its customers once a month. The company will record the expenses and revenue even if the customer has not submitted the payment. Then, for the month when the service has already been sold, the accountant will accrue revenue on the balance sheet and record the expenses, even without payment from a customer.
The accrual method of accounting is recommended by the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP). These two accounting frameworks guide businesses on how to account for expenses or revenue transactions done in the absence of cash payments or receipts.
What is cash accounting?
Cash accounting is a bookkeeping method that recognises and records expenses and revenues when they are actually paid and received. This method of tracking a company’s finances allows small businesses to keep track of their cash flow.
On a cash basis, no bookkeeping is required. For example, if sales are on credit (account receivable) or purchases taken on credit (account payable), once the debt is cleared, then the transaction is recorded.
Record keeping for cash basis accounting looks like a personal bank account transaction. The single-entry system indicates the amounts debited and credited, all in one ledger.
Accrual accounting vs. cash accounting
Whether accrual or cash accounting, it’s vital for a business to have a written report showing the accumulated information about their financial position, performance, and cash flow.
Choosing between accrual and cash accounting solely depends on your type of business and the time period for your business. Accrual accounting is most suitable for corporations with high annual revenue, while cash accounting is best for personal finances and small businesses. A small business, in this case, is a privately owned partnership or sole proprietorship with few employees.
Types of accrual accounts
There are various types of accrual accounts. They include:
- Account receivable: is any payment a customer owes after purchasing goods or services from a business. After the debit is received, it’s recorded as an asset on the company’s balance sheet. This is because it adds value to the company.
- Account payable: is money you or a company owes suppliers or lenders after acquiring goods or services on credit.
- Goodwill: accounting goodwill is an intangible asset that arises when a company buys another existing business. Specifically, goodwill is the higher portion between the purchase price and the net value of all the liabilities assumed and assets purchased in an acquisition.
- Accrued interest earned: refers to the accumulated interest incurred on a financial obligation such as a loan but has not been paid out.
- Accrued tax liabilities: is the amount of tax a business owes but has not been paid out. It’s also known as accrued expenses. Accrued expenses are listed on the balance sheet under current liabilities.
Accrual accounting principles
Accrual accounting combines the following key principles:
Revenue Recognition Principle
Revenue is the money a business makes after selling a product or service to a customer. The revenue recognition principle states that even though a company will collect payment from a customer at a later date, the transaction is recorded during the period when the sale has occurred.
This method results in a difference between the reported revenue and the cash collected from customers within a particular accounting period. For example, assume you have sold a product to a customer worth €500 at the end of the month, and the customer promises to pay the next month. With respect to the revenue recognition principle, you will record the transaction during the product’s sale period (at the end of the month) in your balance sheet.
In a business, expenses are costs incurred to generate revenue. The matching principle states that a company should record the expenses paid during the same accounting period as the revenue generated.
For example, suppose you bought products at the end of the month worth £100 but sold them at the beginning of the following month. Under the matching principle, your books should reflect the €100 as an expense for the beginning of the month, because it’s when you sold the products. The matching principle tallies costs and revenues, making a proprietor understand how liquid the business is.
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