Ahead of a serious of articles regarding the Sage Accounts month end process Paul from Michael Paul Accountants Northamptonshire explains the concept of accruals which form part of the month end procedure. This article is relevant to both users and non users of Sage
What is an accrual?
An accrual is a method by which expenses are reported when incurred, not paid and income is reported when it is earned, not received.
Accounts should always be prepared on an accruals basis.
An example of a situation in which an accrual may be needed is when dealing with utilities. Say a company which produces a monthly profit and loss report receives a quarterly invoice for it’s electricity consumption dated 31 March which covers the electricity used in the previous 3 months (i.e 1 January – 31 March). In this case the monthly profit and loss accounts for January and February would show nil electricity costs and the profit and loss account for March would show the cost of the whole invoice. As already stated accounts should always be prepared on an accruals basis (accounting for income when earned and expenses when incurred) so unless an accrual adjustment is made the accounts will be inaccurate.
When dealing with accruals it is sometime necessary to make an estimate of the accrual value. In the case above when the January profit and loss account is prepared the exact amount of electricity used during January may not be known. However an accrual still needs to be made to include the January electricity costs in the monthly profit and loss account so an estimate will need to be made.
So how does the accrual adjustment work?
Using the above example lets say an estimate is made of the electricity usage in January and February as £400 per month and then when the final bill arrive in March the actual cost for the quarter is £1,500.
In January a journal will be made to debit the electricity expense account in the profit and loss with £400 and then the accrual account in the balance sheet would be credited with £400.
In February the journal will be repeated. There will now be a credit balance in the accruals account for electricity of £800.
In March the electricity invoice will be entered in the normal way. As at the end of March all electricity used has now been charged for no accrual is needed so a journal entry will be made in March to reverse the accrual balance to date which will debit the accruals account with £800 and credit the profit and loss electricity expense account with £800.
The overall effect of this is that the electricity expense account will show the following entries
- January – £400
- February – £400
- March – £700
In hindsight it appears that there has been an under-accrual of the amounts for January and February. If the electricity costs have been equal over the 3 months then an accrual of £500 in January and February would have resulted in every month showed £500. However the current scenario is better than not making any adjustment at all and the whole cost falling in March.
In April the electricity accrual process will start again until the quarterly bill is received in June.
At Michael Paul Accountants Kettering, Corby, Northampton and Market Harborough are conveniently located near to our premises in Lamport although we have clients from all over the UK. We are a firm of Chartered Certified Accountants ensuring you receive a professional and competent service at all times. We specialise in small businesses, medium sized businesses, sole traders, partnerships and individuals who have to file a tax return.
If you need any advice regarding accruals or any other accounting or taxation matters please don’t hesitate to contact us.