An accrual adjustment is required when a transaction occurs before an accounting period-end but the associated receipt or invoice is received or issued after the period-end.
For example, let’s say that a business receives some goods from a supplier on 31st July 2020 (the last day of its accounting year) but the supplier issues the invoice for the goods on 1st August 2020. That invoice will then be recorded in the business’ Purchases Day Book with the other invoices for August and, unless an adjustment is made, will be treated as a cost for the business in the year-ended 31st August 2021.
An adjustment therefore needs to be made to bring this cost forward so that it is recorded in the year in which the goods were received, that is, the year ended 31st August 2020. This type of adjustment is known as an ACCRUAL.
Types of accrual
There are two types of accruals; accrued expenses and accrued income.
An accrued expense occurs when goods or services have been received by a business before the period-end but the associated invoice or receipt is dated after the period-end.
|Gas & electricity||Energy used by business is often billed at the end of a quarter (i.e. a three month period)|
|Professional fees (e.g. accountancy fee)||Many professional firms work for a business and issue their invoices after the work is completed|
|Telephone||Businesses often pay for their landlines on a quarterly basis|
|Bank charges||Banks often bill their business customers on a quarterly basis|
Accrued income occurs when a business supplies goods or services before the accounting period-end but are invoiced for after the accounting period-end.
If we look at the above table of common types of accrued expenses, we can see that a business that supplies any of these goods or services will need to record accrued income for those goods or services that have been supplied before they charge their customers or clients.
Determining the value of an accrual
Sometimes it is easy to determine the value of an accrual that needs to be recorded at the period-end. Let’s say for example, that a business has a year-end of 31st May. On 30th June 2020 it receives an invoice for £1,000 plus VAT from its solicitor for work carried out by the solicitor in April and May 2020 (i.e. before the year-end). A year-end accrual of £1,000 will therefore have to be recorded to increase the business’ legal expenses for the year ended 31st May 2020 and then ensure that this amount is not included in the legal expenses for the year ended 31st May 2021 (note that we should just accrue for the net amount and not include any of the VAT).
Sometimes however, it might not be as straightforward and we might have to use estimates and perform some calculations. To give a simple example, let’s say that a business has a year-end of 30th June 2020. On 1st August 2020 it received an electricity bill for £900 plus VAT covering the electricity used by the business from 1st May 2020 to 31st July 2020. Two of the months covered are before the year-end and as a result, part of this invoice should be accrued for at the year-end. We will not however, know exactly how much should be accrued for unless a meter reading was taken at the year-end. Instead, we will have to estimate the cost of the electricity used in June 2020. In the absence of any additional information it is reasonable to calculate this as being one third of the total cost of the quarter ended 31st July 2020; that is, £300 (again we would not include any VAT).
Recording an accrual
When recording an accrual we will:
- Increase the expense or income for the year
- Record an asset (when an accrued expense is being recorded) or a liability (when accrued income is being recorded)
We will look at the this is detail over the next two pages.