Accruals 

Accruals are adjustments made in the accounts before the Financial Statements are signed off. They can be:

Revenues or assets earned but not entered into the accounting system
Expenses
, losses or liabilities occurred but not entered into the accounting system.

 They may not be entered because:

  • the supplier was late in submitting an invoice 
  • the supplier’s invoice has been lost or held up in the approval process 
  • a job was completed however an invoice was not raised in the system. 

In double entry bookkeeping, the offset to an accrued expense is an accrued liability account, and the offset to an accrued income, is an accrued asset account, which also appears on the balance sheet. 

An accrual is generally a best ‘informed’ estimate. 

For example, we have the electricity expense, which is generally $2,500 for the quarter, however, the invoice has not yet been received.
We would accrue roughly $833.33 per month to ensure that the electricity is accurately reflected in the accounts each month, until the invoice is received. 

Accrual Example

The electricity is on average $2,500 per quarter, or $833.33 per month.
The invoice is received at the end of the quarter, so the first two months must be accrued to make sure the expense is accurately reflected. In our example, the electricity invoice is received on the 30th March amounting to $2,680.56.

JANUARY ACCOUNTS
Accrual Journal required
Debit Electricity account $833.33
Credit Accruals Liability Account $833.33

FEBRUARY ACCOUNTS
Accrual Journal required
Debit Electricity account $833.33
Credit Accruals Liability Account $833.33

MARCH ACCOUNTS
Journal entry required to account for the Invoice
Debit Electricity account $2,680.56
Credit Bank $2, 680.56

Journal to release the accrued amount
Credit Electricity account $1,666.67
Debit Accruals Liability Account $1,666.67

Electricity Account
January $833.33
February $833.33
March $1,013.89

In our example, the amount accrued was lower than the actual, resulting in the March expense being higher than the first two months. 

Prepayments

These are the opposite of the accruals.
The invoice has been entered, the cost has been paid, yet the benefit has not yet been received. A good example for this is the insurance expense for the business, which is paid in advance for the year or 6 months. 

Prepayment Example  

Insurance expense for the business is $12,000, and it is covering 6 months of the year. It is paid in June to cover the period July – Dec.   

JUNE ACCOUNTS
Debit Prepayment Liability account $12,000
Credit Bank $12,000

JULY - DECEMBER ACCOUNTS
Debit Insurance Account $2,000
Credit Prepayment Liability account $2,000

Both, the Prepayments and the Bank accounts are the Balance Sheet accounts.
The total insurance paid in June covers the insurance premium from July to December. Therefore, it does not affect the June's Profit and Loss account as per the Matching Principle. 

Reserves

Reserves are made to cover an event that may happen (or that has happened), but that is not adequately recorded in the books. 

Common reserve accounts are set up to cover bad debts, purchase fixed assets, pay for repairs and maintenance or pay bonuses. If funds have been directed to a specific reserve account (e.g. bad debts), there is no legal obligation that these funds can only be used for this purpose. They can be used for any purpose the business requires. 

A bad debt reserve is probably the most common reserve account. 

Amazon sellers are aware that Amazon withholds a portion of their settlements in the early days to protect themselves against the ‘unknown’ seller. Once the sales start to increase and Amazon has essentially received good feedback about the seller, Amazon will start to slowly reduce the amount they hold in reserve. 

Provisions

These are very similar to reserves and in some cases the two terms are almost interchangeable. A provision is an amount that is set aside for an estimated expense, whereas the reserve accounts are an amount set aside for a specific purpose. 

Depreciation 

Fixed Assets are those assets that hold a value for a long time, generally understood as over a year. Examples include motor vehicles, plant and machinery, and computer equipment. While some assets will hold their value indefinitely, most assets do not. 

The value of assets reduces with time (leases), wear and tear (computer equipment) or both. It is therefore necessary to write off the value of these assets over their economic useful life. The accounting standards can provide guidance on what is considered a useful life.  

The depreciation account is found on the Profit and Loss account and reduces the profit. 

There are several ways to calculate depreciation:

  • Straight line method: An equal amount is written of over a fixed number of years. 
  • Reducing balance method: This method writes of a percentage of the remaining balance.  

These are the two most common methods, however, there are others you should consider and, with your accountant’s help, decide which is the best option for you and your business. The applied method must be used consistently year on year.    

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