What are accruals?

It has been a long-accepted accounting principle that revenue and costs should be recognised as they are earned or accrued, rather than when their cash value is received or paid.

Income and expenditure should be matched with one another where possible, and reflected in the profit and loss account for the period.  In accounts – this is called the matching principle.

An accrual is a provision for a cost that we have not yet been billed for. We want the cost to appear in our accounts as we have incurred the liability and we know we will have to pay the supplier –  but we have not got the invoice yet.

An accrual represents a current liability in the balance sheet and a cost to the profit and loss account.

For example telephone costs may be invoiced on a quarterly basis, so a monthly accrual is charged or debited to the  profit and loss account and credited to the balance sheet accruals account. When the invoice is received at some point in the future, the accrual is reversed to offset the invoice received, with the costs already accrued. This ensures that we spread the quarterly bill over the individual months in each quarter.

Lets look at the accounting entries:

January -xx

Say we want to accrue £50 of telephone costs in January. We will create a journal entry for our accrual.

31-Jan- xx   Being an accrual of £50 for monthly telephone costs billed quarterly
Transaction Debit Credit
Telephone costs (P&L)  50
Accruals (BS)  50
Journal total 50 50

February-xx

Say we want to accrue another £50 of telephone costs in February as we have not received the quarterly invoice yet. We will create another journal entry for our February accrual.

28-Feb- xx   Being an accrual of £50 for monthly telephone costs billed quarterly
Transaction Debit Credit
Telephone costs (P&L)  50
Accruals (BS)  50
Journal total 50 50

March-xx

Say we receive our quarterly invoice for telephone costs in March of £155 plus VAT. We will reverse the £100 of telephone costs we have accrued to date.

  • You can reverse each individual journal, or create a single journal to reverse the costs you have accrued to date.
31-Mar- xx   Being the reversal of monthly telephone costs accrued on receipt of quarterly invoice.
Transaction Debit Credit
Telephone costs (P&L) 100
Accruals (BS) 100
Journal total 100 100

 

In your profit and loss account – telephone costs for the quarter will have been:

  • £50.00    January-xx
  • £50.00    February-xx
  • £55.00    March-xx   (The invoice of £155 + VAT, less accrued costs of £100)

In your balance sheet – the balance of your accruals account would have been:

  •  £50.00      January-xx      (£50)
  • £100.00    February-xx    (£50 + £50)
  • £0.00         March-xx        (£50 + £50 – £100)

As you have now received an invoice, your accruals account will have a nil balance, but you will have a creditor or accounts payable balance of £186 (£155 + VAT) until the invoice is paid.

Top Tips

  • Don’t forget that costs are accrued net of VAT
  • Keep an eye on your accruals account in the balance sheet, reconcile regularly to ensure that you don’t have carried forward accruals for costs that are no longer required.
  • One way of avoiding forgotten accruals – is to auto reverse them at the beginning of the next month forcing you to review the account each month end.
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