Accruals

Updated: Sep 2, 2019

To understand accruals, we must first understand the different reporting frameworks available to entities.


There are two different methods of reporting business income: cash method and accrual method. Cash method means that revenue is recorded when cash is received. This is not acceptable under the IFRS reporting framework. However, some Canadian private companies, reporting under ASPE are allowed to use this method when reporting on business income. Examples of companies under ASPE that can use the cash basis of accounting include: commission businesses, farming and fishing businesses.


The second, most widely used method of reporting income is called the “accrual method”. This is the only method allowed under IFRS, and the majority of businesses operating under the Canadian ASPE guidelines also use this method. If you recall, it is also one of the underlying assumptions - that financial statements are presented using the accrual method.


“To accrue” something literally means to accumulate. In accrual accounting, we follow the Revenue (IFRS and ASPE) and Expense recognition criteria we have reviewed in prior articles, where Revenues and Expenses can only be booked when the recognition criteria are met (when the services have been rendered, or the expenses have been incurred). So what do we do with the remainder of the balance? We accrue it into different accounts.


Accrued Revenue is Revenue that has been earned by the entity, but has not yet been invoiced. This is considered a current asset on the Statement of Financial Position/Balance Sheet. For example, an entity may have delivered the goods or services, but has not yet received cash for those services, so we accrue this into an asset account. Note that Accrued Revenue differs from Accounts Receivable. Accounts Receivable (discussed in the "Accounts Receivable" article) are also current assets stemming from Revenue, which has been earned. The difference is that with Accounts Receivable, an invoice has already been issued.


Accrued Expenses are Expenses that have been incurred, but have not yet been billed or paid. Examples include any services which may have been used (water, electricity, etc..) but are only billed intermittently (e.g. quarterly). The entity is slowly accumulating an expense, over time. This accrual shows up as a current liability on the Balance Sheet/Statement of Financial Position. Note that Accrued Expenses differ from Accounts Payable. Accounts Payable (discussed in a later article) are also current liabilities stemming from Expenses, which have been incurred. The difference is that with Accounts Payable, an invoice has already been issued.


Unearned Revenue is also a type of accrual. An example of unearned revenue is if a client has paid for a good or a service in advance, and the entity has not yet delivered this good/service. In this situation, the accrual is considered a Liability, because the entity owes the client something that has not yet been provided. This accrual shows up as a Liability on the Balance Sheet/Statement of Financial Position.


Scenario 1:


A company charges a lump sum of $120 at the beginning of the year for services rendered throughout the year: January 01-December 31.


If the company receives the cash on January 01, the following journal entry would be recorded:


January 01:


This is a liability accrual of $120, accumulated at the beginning of the year, when cash is initially received, for a service not yet rendered.


At the end of each month, the company will need to record the Revenue which pertains to the services provided.


End of each month:


Assuming services are rendered equally throughout the year (e.g. software subscription), we would simply divide the full year’s earnings by 12 and recognize revenue for each month of that year, at the end of the month. This will reduce the accrual (liability) by $10 each month.


Scenario 2:


A company charges a lump sum of $120 at the beginning of the year for services rendered throughout the year: January 01-December 31.


If the company has not yet invoiced for the services, and has not yet received any cash, the following journal entry would be recorded:


January 01:


This is a liability accrual of $120, and an asset accrual of $120, accumulated at the beginning of the year, when the invoice is initially sent to the client.


At the end of each month, the company will need to record the Revenue which pertains to the services provided.


End of each month:


This assumes that the client has not yet paid their invoice and that services are rendered equally throughout the year (e.g. software subscription). We would simply divide the full year’s earnings by 12 and recognize revenue for each month of that year, at the end of the month. This will reduce the accrual (liability) by $10 each month.


Once payment has been received, we can also reduce the Accounts Receivable asset accrual:

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