Accrual

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Accrual (accumulation) of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting. These types of accounts include, among others, accounts payable, accounts receivable, goodwill, deferred tax liability and future interest expense. [1]

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Accruals in accounting

For example, a company delivers a product to a customer who will pay for it 30 days later in the next fiscal year, which starts a week after the delivery. The company recognizes the proceeds as a revenue in its current income statement still for the fiscal year of the delivery, even though it will not get paid until the following accounting period. [2] The proceeds are also an accrued income (asset) on the balance sheet for the delivery fiscal year, but not for the next fiscal year when cash is received.

Similarly, the salesperson who sold the product earned a commission at the moment of sale (or delivery). The company will recognize the commission as an expense in its current income statement, even though the salesperson will actually get paid at the end of the following week in the next accounting period. The commission is also an accrued liability on the balance sheet for the delivery period, but not for the next period when the commission (cash) is paid out to the salesperson.

The term accrual is also often used as an abbreviation for the terms accrued expense and accrued revenue that share the common name word, but they have the opposite economic/accounting characteristics.

Accrued revenue

Accrued revenue (or accrued assets) is an asset, such as unpaid proceeds from a delivery of goods or services, when such income is earned and a related revenue item is recognized, while cash is to be received in a later period, when the amount is deducted from accrued revenues.

In the rental industry, there are specialized revenue accruals for rental income which crosses month end boundaries. These are normally utilized by rental companies who charge in arrears, based on an anniversary of a contract date. For example, a rental contract which began on 15 January, being invoiced on a recurring monthly basis will not generate its first invoice until 14 February. Therefore, at the end of the January financial period an accrual must be raised for sixteen days' worth of the monthly charge. This may be a simple pro-rate basis (e.g. 16/31 of the monthly charge) or may be more complex if only week days are being charged or a standardized month is being used (e.g. 28 days, 30 days etc.)

Accrued expense

Accrued expense is a liability whose timing or amount is uncertain by virtue of the fact that an invoice has not yet been received. [3] The uncertainty of the accrued expense is not significant enough to qualify it as a provision. An example of an accrued expense is a pending obligation to pay for goods or services received from a counterpart, while cash is to be paid out in a later accounting period when the amount is deducted from accrued expenses.

Under International Financial Reporting Standards, this difference is best summarized by IAS 37 which states:

"11 Provisions can be distinguished from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. By contrast:

"(a) trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier; and

"(b) accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.

"Accruals are often reported as part of trade and other payables, whereas provisions are reported separately."

To add to the confusion, some legalistic accounting systems take a simplistic view of 'accrued revenue' and 'accrued expenses", defining each as revenue or expense that has not been formally invoiced. This is primarily due to tax considerations, since in some countries, the act of issuing an invoice creates taxable revenue, even if the customer does not ultimately pay and the related receivable becomes noncollectable.

Accruals in payroll

In payroll, a common benefit that an employer will provide for employees is a vacation or sick accrual. This means that as time passes, an employee accumulates additional sick leave or vacation time and this time is placed into a bank. Once the time is accumulated, the employer or the employer's payroll provider will track the amount of time used for sick or vacation.

Length of service

For most employers, a time-off policy is published and followed with regard to benefit accruals. These guidelines ensure that all employees are treated fairly with regard to the distribution and use of sick and vacation time.

Within these guidelines, the rate at which the employee will accumulate the vacation or sick time is often determined by length of service (the amount of time the employee has worked for the employers).

Trial period

In many cases, these guidelines indicate there is a trial period (usually 30 to 90 days) where no time is awarded to the employee. This does not prevent an employee from calling in sick immediately after being hired, but it does mean that they will not get paid for this time off. However, it does prevent an employee, for example, scheduling a vacation for the second week of work. After this trial period, the award of time may begin or it may be retroactive, back to the date of hire.

Rollover/carry over

Some accrual policies have the ability to carry over or roll over some or all unused time that has been accrued into the next year. If the accrual policy does not have any type of rollover, any accrued time that is in the bank is usually lost at the end of the employer's calendar year.

Other uses

When referring to clinical trials, the definition of "accrual" is either the process of recruiting patients into a trial, or the number of patients in a trial. [4]

See also

Related Research Articles

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Expenditure is an outflow of money, or any form of fortune in general, to another person or group to pay for an item or service, or for a category of costs. For a tenant, rent is an expense. For students or parents, tuition is an expense. Buying food, clothing, furniture or an automobile is often referred to as an expense. An expense is a cost that is "paid" or "remitted", usually in exchange for something of value. Something that seems to cost a great deal is "expensive". Something that seems to cost little is "inexpensive". "Expenses of the table" are expenses of dining, refreshments, a feast, etc.

National Insurance Tax and social benefit system in the UK, introduced in 1911

National Insurance (NI) is a fundamental component of the welfare state in the United Kingdom. It acts as a form of social security, since payment of NI contributions establishes entitlement to certain state benefits for workers and their families.

Accounts payable Money owed by business to its suppliers

Accounts payable (AP) is money owed by a business to its suppliers shown as a liability on a company's balance sheet. It is distinct from notes payable liabilities, which are debts created by formal legal instrument documents.

Accounts receivable Claims for payment held by a business

Accounts receivable, abbreviated as AR or A/R, are legally enforceable claims for payment held by a business for goods supplied or services rendered that customers have ordered but not paid for. These are generally in the form of invoices raised by a business and delivered to the customer for payment within an agreed time frame. Accounts receivable is shown in a balance sheet as an asset. It is one of a series of accounting transactions dealing with the billing of a customer for goods and services that the customer has ordered. These may be distinguished from notes receivable, which are debts created through formal legal instruments called promissory notes.

Cash flow statement

In financial accounting, a cash flow statement, also known as statement of cash flows, is a financial statement that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. Essentially, the cash flow statement is concerned with the flow of cash in and out of the business. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 is the International Accounting Standard that deals with cash flow statements.

Year-to-date (YTD) is a period, starting from the beginning of the current year and continuing up to the present day.

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Deferred income is, in accrual accounting, money received for goods or services which has not yet been earned. According to the revenue recognition principle, it is recorded as a liability until delivery is made, at which time it is converted into revenue.

Deferral Term in accounting

A deferral, in accrual accounting, is any account where the income or expense is not recognised until a future date, e.g. annuities, charges, taxes, income, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability. See also accrual.

Chart of accounts

A chart of accounts (COA) is a list of financial accounts set up, usually by an accountant, for an organization, and available for use by the bookkeeper for recording transactions in the organization's general ledger. Accounts may be added to the chart of accounts as needed; they would not generally be removed, especially if any transaction had been posted to the account or if there is a non-zero balance.

Adjusting entries

In accounting/accountancy, adjusting entries are journal entries usually made at the end of an accounting period to allocate income and expenditure to the period in which they actually occurred. The revenue recognition principle is the basis of making adjusting entries that pertain to unearned and accrued revenues under accrual-basis accounting. They are sometimes called Balance Day adjustments because they are made on balance day.

Revenue recognition

The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle. They both determine the accounting period in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and are earned, no matter when cash is received. In cash accounting – in contrast – revenues are recognized when cash is received no matter when goods or services are sold.

Matching principle

In accrual accounting, the revenue recognition principle states that revenues should be recorded during the period in which they are earned, regardless of when the transfer of cash occurs. And the matching principle instructs that an expense should be reported in the same period in which the corresponding revenue is earned, and is associated with accrual accounting. By recognizing costs in the period they are incurred, a business can see how much money was spent to generate revenue, reducing "noise" from timing mismatch between when costs are incurred and when revenue is realized. Conversely, cash basis accounting calls for the recognition of an expense when the cash is paid, regardless of when the expense was actually incurred.

Compensation of employees (CE) is a statistical term used in national accounts, balance of payments statistics and sometimes in corporate accounts as well. It refers basically to the total gross (pre-tax) wages paid by employers to employees for work done in an accounting period, such as a quarter or a year.

Accrued liabilities are liabilities that reflect expenses that have not yet been paid or logged under accounts payable during an accounting period; in other words, a company's obligation to pay for goods and services that have been provided for which invoices have not yet been received. Examples would include accrued wages payable, accrued sales tax payable, and accrued rent payable.

Fund accounting

Fund accounting is an accounting system for recording resources whose use has been limited by the donor, grant authority, governing agency, or other individuals or organisations or by law. It emphasizes accountability rather than profitability, and is used by Nonprofit organizations and by governments. In this method, a fund consists of a self-balancing set of accounts and each are reported as either unrestricted, temporarily restricted or permanently restricted based on the provider-imposed restrictions.

Interest expense relates to the cost of borrowing money. It is the price that a lender charges a borrower for the use of the lender's money. On the income statement, interest expense can represent the cost of borrowing money from banks, bond investors, and other sources. Interest expense is different from operating expense and CAPEX, for it relates to the capital structure of a company, and it is usually tax-deductible.

Basis of accounting

A basis of accounting is the time various financial transactions are recorded. The cash basis and the accrual basis are the two primary methods of tracking income and expenses in accounting.

United States v. General Dynamics Corp., 481 U.S. 239 (1987), is a United States Supreme Court case, which hold that under 162(a) of the Internal Revenue Code and Treasury Regulation 1.461-1(a)(2), the "all events" test entitled an accrual-basis taxpayer to a federal income tax business-expense deduction, for the taxable year in which (1) all events had occurred which determined the fact of the taxpayer's liability, and (2) the amount of that liability could be determined with reasonable accuracy.

References

  1. "Accruals". Investopedia.com. Archived from the original on 30 December 2009. Retrieved 6 January 2010.
  2. "Accrual Accounting". Investopedia.com. Archived from the original on 5 January 2010. Retrieved 6 January 2010.
  3. Haber, Jeffry R (2004). Accounting demystified. AMACOM Div American Mgmt Assn. p. 91. ISBN   978-0-8144-0790-5 . Retrieved 2 April 2012.
  4. "Clinical Trials Dictionary". CancerGuide.org. Retrieved 5 May 2012.