Accountants do a lot of accruals and there's a running joke (Pinterest) that the world they live in is indeed a cruel one.
What are accruals? If you look closer, they might be the reason why accounting is hard to understand (and cruel).
There are actually two bases of accounting - Cash vs Accrual. Under the cash basis, revenues and expenses are recorded when cash is received or paid. Under the accrual basis, revenues are recognised when earned and expenses recognised when incurred and are matched with revenue.
The reason for accrual accounting is that it serves to reflect economic events and not just cash changing hands arbitrarily.
Because of timing differences in delivery and payment, we often end up with different results under each basis.
Most, if not all, accounting standards around the world require the use of accrual accounting. This's where complexity comes in, because unlike cash where you can actually see a transaction taking place, accrual accounting uses concepts like 'earned' and 'incurred' that involve judgement.
What accruals mean for you
As a business owner, you need your financial statements to be accurate and based on accounting principles. Very often, you’ll accrue for revenue and expenses first and account for cash later. In fact, accruals are so prevalent that the common items that you see like accounts receivable, unearned revenue and accrued expenses are all results of accrual accounting.
It's equally useful to recognise accruals in the financial reports of other companies, whether you're deciding to invest or work with them.
Accruals often carry subtle implications about the company's situation. For example, an accounts receivable balance that increases at a much higher pace compared to sales could suggest abnormal sales and future collection issues. When this happens, you'll be ill-advised to jump to a haste decision without finding out more.
At Squarebook, we seek to make accounting accessible to you. We can help you with your bookkeeping and financial statements preparation so that you make business decisions based on accurate information. Talk to us about your accounting questions today.
