Accruals — are the funds indicated as income or expenses that have to be paid off. The control and timely payment of accruals allow the accountant to control the financial state of the company. Accruals are calculated by reconciliation of the entries after every accounting period.
There are two types of accruals: expenses and revenues. Expenses — are the spending that leads to a decrease in the economic benefits. Revenues — are the funds generated by the sale of goods or services. They both should be placed in one period. This is necessary to identify the unpaid liabilities. Accruals are necessary to provide the precise data for the management. The monitoring of accruals allows the company to avoid debts and lawsuits with clients.
Accruals in different methods of accounting
The bookkeepers apply two methods of accounting. The first one is based on the supply of funds to the supply of funds (cash-basis accounting). The second one relies on the time of actual receipt of funds (accrual-basis accounting). The selection of methods depends on the organization.
Accrual-basis accounting — is an accounting treatment where incomes and spending are registered in the period when they had appeared, without taking into account the time of reaching the cash desk. In most cases, bookkeepers apply this practice for work because it allows them to stick to the matching principle and the principle of revenue recognition. According to them, the proceeds should be entered when they are earned, and revenues should be registered when the client receives the product. The accountant doesn’t have to know when the funds have changed the owner, thereby diminishing the influence of timing and providing more accurate information concerning the financial state.
Cash-basis accounting — is an accounting treatment where all funds are entered at the time funds were contributed to the cash desk or paid off. This method is quite simple because you just need to oversee the movement of funds, and the money is recorded at the moment of the financial operation. You don’t need to consider any funds until they will be paid. Just monitor the cash and compute the taxes based on the net income.
How to choose the method to calculate the Accruals
It may be difficult to define the appropriate method of accounting to monitor the accruals. To do so, you need to consider several factors:
- Size of business. The sole proprietors and big enterprises have different bookkeeping needs because they have different numbers of clients, employees, commodities, and materials.
- Plans for the future. If you are currently expanding, it is better to select the accounting method suited for the company you aim to be. The more you grow, the more employees or commodities and materials you will need.
- Structure of business. The accrual accounting suits the big corporation and the cash-basis accounting is better for freelancers or small shops.
- Presence of investors. You plan to attract the investors or if you have already done it, The accounting method should also satisfy them.
Accruals in reversing entries
Reversing entry — a record where the accountant transfers the cost of debt from one account to another. Reversing entries are applied in the accrual-basis accounting to control the balance between income and expenses. Without the reversal entries, the balance won’t be correct.
Most accruals were made as reversing entries, so the bookkeeping software automatically annuls them in the next month. It happens when you're expecting money to be paid in the following reporting period. The accountants often follow this practice. Accrual entry may stay on the balance, when no one notices that it wasn’t reserved. Accountants just delete the unnecessary record.