Explain Accounting "accruals" to me

Factual Questions
1

At work because of the slack workload and holidays they are encouraging everyone to take their vacations now.

Accounting is short, so I said I’d help out. Now I am no accountant, but I have worked in accounting before, I have done a/p and a/r and understand the basic, debits, credits, I can do a balance sheet and make journal entries, and I get the chart of accounts.

One thing I am just not getting and the controller is looking at me like I’m a moron. Which I probably am, she’s good at explaining things but this I don’t get.

What are accurals? She said I need to get the accruals from each dept and make sure they are accurate. It seems to me they have something to do with bonuses. She also uses the term like, we have to know how many points we give our clients (points are airline points which we give out as bonuses) as the cost us 1.8¢ per point. She said that is money we have to accrue for.

She says the money from the dept bonuses must be accrued for, so she says get these stats. So I go to the depts like sales and they give me numbers for bonuses they think will be paid out.

I am just not getting this. Can an accountant please explain this to me, and where they are going with regards to the P&L. They obviously are some sort of liability that must be on the P&L.

But how can you check the accuracy, is what I am not getting.

Sorry if this is a bit off, but I get everything else she tells me, but this accruals is just stumping me. So you have to explain it to me like I’m seven years old :slight_smile:

2

Accruals are income you have earned or expenses you have incurred which have yet to be paid. For example, 2007 bonuses may not be paid until 2008, but they belong on the 2007 records (the period incurred). So you book the expense and offset it with an accrual. When you pay, you close the accrual versus the cash.

(For the record, while I have a 20+ year old accounting degree, I have never been nor will ever be an accountant. I do, however, work in the financial services industry and work with this concept often. So, while I do understand the concept, I have no idea which side is the credit and which side is the credit - I just know they need to offset)

3

[QUOTE=D_Odds]
Accruals are income you have earned or expenses you have incurred which have yet to be paid.
[/QUOTE]

May I ask, how is that different from Accounts Payable?

4

Cash vs. Accrual Accounting

http://taxguide.completetax.com/text/Q11_2208.asp

[QUOTE=Usram]
May I ask, how is that different from Accounts Payable?
[/QUOTE]

Only in when it gets counted for tax purposes.

http://www.toolkit.com/small_business_guide/sbg.aspx?nid=P06_1340

http://www.irs.gov/businesses/small/article/0,,id=98680,00.html

5

In my line of work, I book accrual entries - and you ask how it’s different from A/P. The prime difference is that you haven’t received an invoice yet.

You’ve got this vendor who is doing some work for you. Maybe he’s delivered a widget. This widget is worth $10,000 and you received it on November 29th. But the invoice hasn’t arrived yet. For your November financial records, you want to recognize the expense, because it’s the month you actually received the thing (basic accounting says you recognize the expense in the period it is incurred - since you got the widget, you now have an obligation to pay for it). So in November’s ledger, you would “accrue for” the widget:

Debit - Widget Expense (or whatever expense account you’d use for it)
Credit - Accrued Liabilities

In December, when you get the invoice, and your A/P folks enter it, they will do one of two things:

Debit - Widget Expense
Credit - Accounts Payable

Debit - Accrued Liabilities
Credit - Accounts Payable

In scenario #1 you’d need to book an additional entry in December:

Debit - Accrued Liabilities
Credit - Widget Expense

This offsets the invoice and results in a net zero expense in December (which is good, because you expensed it in November). At my job, this entry is called “reversing the accrual.”

The second scenario is “easier” because it involves fewer transactions, but your A/P folks would need to know that someone has accrued for the widget. If you worked in a huge corporation with lots of worker bees, this isn’t always going to be possible. So ideally you’d make the accrual reverse, and A/P charges the invoice to the expense it belongs to.

Wow, do I feel nerdy.

6

[QUOTE=D_Odds]
So, while I do understand the concept, I have no idea which side is the credit and which side is the credit - I just know they need to offset.
[/QUOTE]

Ah, grasshopper. It all depends on what you’re accruing! You can accrue for things with a natural debit balance and you can accrue for things with a natural credit balance. What you do for accruing an expense will be different for what you do when you accrue revenue.

7

[QUOTE=Usram]
May I ask, how is that different from Accounts Payable?
[/QUOTE]

Basically, they are the same but with AP you have an invoice in your hand already showing that you incurred the expense on such and such a date but will be paying it in the future some time. If you don’t have an invoice you can still accrue the expense if necessary.

A good example would be accruing commissions to a salesman related to a specific sale that you have already invoiced to the customer. Even if you don’t get invoices from that salesman, you want to calculate and record the commission expense in the same period that you record the sale.

8

[QUOTE=Nman]
She said I need to get the accruals from each dept and make sure they are accurate. It seems to me they have something to do with bonuses. She also uses the term like, we have to know how many points we give our clients (points are airline points which we give out as bonuses) as the cost us 1.8¢ per point. She said that is money we have to accrue for.

She says the money from the dept bonuses must be accrued for, so she says get these stats. So I go to the depts like sales and they give me numbers for bonuses they think will be paid out.

I am just not getting this. Can an accountant please explain this to me, and where they are going with regards to the P&L. They obviously are some sort of liability that must be on the P&L.

But how can you check the accuracy, is what I am not getting.
[/QUOTE]

So, imagine you are going out of business right this second. What have people earned already that you have not paid them, and will owe them? Those are your liabilities. On the other side, you have earned money that perhaps you haven’t actually been paid yet, or you own things you could sell off. Those are your assets.

Acrrual is a way to book these transactions that haven’t happened yet but that have been taken on as part of the business done so far. The bonuses mentioned have been earned and would have to be paid out, so they are part of your business’s overall position, they just haven’t actually been paid out yet. But to say you’re worth a gross amount without counting the money you will owe would be overstating your position.

Have they already been booked as liabilities? Sounds like maybe they haven’t, and you are collecting the amount to be booked for the end of the calendar (tax) year. How to check the accuracy? If there is already an amount booked, you could be verifying that it reflects the sum of the individual bonuses to be paid out. Perhaps the cost per unit has changed? Or you could be coming up with the total figure from the supporting information you collect.

I work for non-profits, so we have an income statement instead of a P&L. But I would think the accrual for the liability would get posted as expenses, decreasing net income on the P&L. This change in owner’s equity on the balance sheet would be offset by the increase in liability.

This is an accrual entry since the expense hasn’t actually happened yet. Presumably the accrual entry is reversed later and the (cash) expense booked in a later period.

9

[QUOTE=scout1222]
Ah, grasshopper. It all depends on what you’re accruing! You can accrue for things with a natural debit balance and you can accrue for things with a natural credit balance. What you do for accruing an expense will be different for what you do when you accrue revenue.
[/QUOTE]

Master, aka Arnold from Happy Days, what is a “natural” debit balance? What is a “natural” credit balance? Huh? As accounting, even double entry, GAAP accounting, is a man-made (ie artificial by definition) construct, how can either debits or credits be “natural”?

10

What I meant was something like “travel expenses” are debits - an operating expense. So you’d debit expense credit an accrued liability account. On the other hand, you could accrue earned revenue - revenue is a credit balance. So you’d book the revenue as a credit, and debit an accrued revenue account.

In other words, an “accrual” is neither a debit nor a credit simply by definition. It would depend on WHAT is accrued. Hopefully that makes more sense.

11

Note as well that accruals are often estimated amounts, as a way of stating that “we know we owe approximately this amount, but we won’t know exactly until the invoice comes” for flexible costs such as payments for ongoing services.

They are also used to more accurately reflect the affect on operations of ongoing costs/revenues which are actually paid in lump sums rather than on an ongoing basis. For an example, this can be used to spread the cost of property tax payments over the full year rather than dumping them all into the month in which they are actually paid, by entering 1/12th of the estimated cost in each month, then adjusting to the actual cost when the tax bill is received.

12

[QUOTE=scout1222]
Ah, grasshopper. It all depends on what you’re accruing! You can accrue for things with a natural debit balance and you can accrue for things with a natural credit balance. What you do for accruing an expense will be different for what you do when you accrue revenue.
[/QUOTE]

I’m just rusty, master. As I keep forgetting, I always turn to one of the nearby accounting weenies ( :smiley: I jest! I jest!..well, only a little) to remind me of whether income books as a debit or credit, then I can reverse engineer from there. But this is on the rare occasion that I need to know the proper accounting treatment.

Another way to think of the difference between accruals and accounts payable is to think of a mutual fund situation. Every day, investors enter or leave the fund. Every day, expenses such as accounting, managerial fees, marketing, etc. need to be allocated to the investors in that fund. If your audit bill for 2007 is expected to be $36,500, but you won’t even see the invoice until sometime in early 2008, you won’t have an account payable. But you will have a known expense that has to be allocated, to the tune of $100/day, to the shareholders of the fund. So everyday, you accrue $100 of expense. That way, the expense is shared by everyone who is in the fund for the period the expense covers, not just the ones who hold shares on the day of invoicing. The same applies to income. A bond accrues income every day, so that if you buy and then sell a bond between interest payment dates, you have still earned money even though the bond issuer hasn’t yet paid. By accruing the interest income, and buying and selling the interest in transactions, the income goes to the appropriate parties, not just the dude holding the bond on pay date.

13

[QUOTE=gigi]
So, imagine you are going out of business right this second. What have people earned already that you have not paid them, and will owe them? Those are your liabilities. On the other side, you have earned money that perhaps you haven’t actually been paid yet, or you own things you could sell off. Those are your assets.

Acrrual is a way to book these transactions that haven’t happened yet but that have been taken on as part of the business done so far. The bonuses mentioned have been earned and would have to be paid out, so they are part of your business’s overall position, they just haven’t actually been paid out yet. But to say you’re worth a gross amount without counting the money you will owe would be overstating your position.

Have they already been booked as liabilities? Sounds like maybe they haven’t, and you are collecting the amount to be booked for the end of the calendar (tax) year. How to check the accuracy? If there is already an amount booked, you could be verifying that it reflects the sum of the individual bonuses to be paid out. Perhaps the cost per unit has changed? Or you could be coming up with the total figure from the supporting information you collect.

I work for non-profits, so we have an income statement instead of a P&L. But I would think the accrual for the liability would get posted as expenses, decreasing net income on the P&L. This change in owner’s equity on the balance sheet would be offset by the increase in liability.

This is an accrual entry since the expense hasn’t actually happened yet. Presumably the accrual entry is reversed later and the (cash) expense booked in a later period.
[/QUOTE]

This makes a bit of sense, the thing is none of these bonuses is due and nothing is earned. The bonus plan says if you’re not here on Dec 31st when they’re given out you don’t get paid. (I don’t think that’s strictly legal, but that’s what the agreement the people who get bonuses say anyway).

Also the airline points are what we EXPECT to pay out but not what we have an obligation. For instance if someone is due 50,000 airline points we want to accrue for them, but until they satisfy their end of the contract they don’t get anything. And it’s based on their purchasse, if they only wind up buyin half the 50,000 points becomes 25,000 points.

14

[QUOTE=Nman]
This makes a bit of sense, the thing is none of these bonuses is due and nothing is earned. The bonus plan says if you’re not here on Dec 31st when they’re given out you don’t get paid. (I don’t think that’s strictly legal, but that’s what the agreement the people who get bonuses say anyway).

Also the airline points are what we EXPECT to pay out but not what we have an obligation. For instance if someone is due 50,000 airline points we want to accrue for them, but until they satisfy their end of the contract they don’t get anything. And it’s based on their purchasse, if they only wind up buyin half the 50,000 points becomes 25,000 points.
[/QUOTE]

Ah, OK. So you could accrue the maximum, assuming everyone will be there Dec 31, and everyone will make the maximum purchase. I assume this would be the most conservative way to do it, and it give syou your upper limit.

However, realistically it is probably overstating what will actually happen. Find out what methodology was used in the past. It’s possible that they expect you to base the accrual estimate on the percentages of people who were there Dec 31 last year, and the percentage of sales that were made last year.

Do you know if the plan worked the same way last year?

15

[QUOTE=Nman]
This makes a bit of sense, the thing is none of these bonuses is due and nothing is earned. The bonus plan says if you’re not here on Dec 31st when they’re given out you don’t get paid. (I don’t think that’s strictly legal, but that’s what the agreement the people who get bonuses say anyway).

Also the airline points are what we EXPECT to pay out but not what we have an obligation. For instance if someone is due 50,000 airline points we want to accrue for them, but until they satisfy their end of the contract they don’t get anything. And it’s based on their purchasse, if they only wind up buyin half the 50,000 points becomes 25,000 points.
[/QUOTE]

Ah, OK. So you could accrue the maximum, assuming everyone will be there Dec 31, and everyone will make the maximum purchase. I assume this would be the most conservative way to do it, and it give syou your upper limit.

However, realistically it is probably overstating what will actually happen. Find out what methodology was used in the past. It’s possible that they expect you to base the accrual estimate on the percentages of people who were there Dec 31 last year, and the percentage of sales that were made last year.

Do you know if the plan worked the same way last year?

16

Sorry for the dupe post.

17

[QUOTE=scout1222]
You’ve got this vendor who is doing some work for you. Maybe he’s delivered a widget. This widget is worth $10,000 and you received it on November 29th. But the invoice hasn’t arrived yet. For your November financial records, you want to recognize the expense, because it’s the month you actually received the thing (basic accounting says you recognize the expense in the period it is incurred - since you got the widget, you now have an obligation to pay for it). So in November’s ledger, you would “accrue for” the widget:

Debit - Widget Expense (or whatever expense account you’d use for it)
Credit - Accrued Liabilities

[etc.]
[/QUOTE]

Bookkeeping is one of those things where the individual words make sense, but the sentences don’t. I don’t know why I find it so hard to grasp - it’s just basic arithmetic, isn’t it?

But, I don’t actually know what you mean by “an account”. Like, a bank account? What exactly are “ledgers”, apart from being big books that you write stuff in, and why are they such a big deal to accountants? And isn’t there some weird voodoo where “debit” and “credit” don’t mean what a layman would expect them to mean?

18

Account = classification. I don’t know if you use something like Quicken to keep track of your checkbook, but if you do, you know how you assign a transaction (like when you go to the store for food) to a category - like groceries? That would be equivalent to what I mean by account.

So at my company, we have a list of accounts that would include stuff like this:

phone revenue
accessories revenue
other revenue
cost of goods sold
salary expense
travel expense
outside services expense

And each of the above are accounts.

As for “ledger” that’s a word for the figurative financial transactions in the company. All of these transactions (paying bills, cutting checks to employees, receiving money from customers) are recorded in what we’d call the ledger.

As for your comment about “voodoo”, you might be thinking about when you deal with your bank. What I, as an accountant, would consider debits and credits are just about the flip of what the bank would say to me as their customer. If I wanted to increase the amount of money in my company’s bank account, I’d say I’m debiting it. The bank would say they are crediting it. Which makes no sense, except it does. For THEM, giving me money is reducing the amount they get. So they are crediting THEIR books, while I’m debiting MINE. That made sense in my head, but I fear it still might be elusive to a non-accountant.

(I can’t believe it’s taken me 7 years of posting to be so active in a GQ thread.)

19

[QUOTE=Usram]
Bookkeeping is one of those things where the individual words make sense, but the sentences don’t. I don’t know why I find it so hard to grasp - it’s just basic arithmetic, isn’t it?

But, I don’t actually know what you mean by “an account”. Like, a bank account? What exactly are “ledgers”, apart from being big books that you write stuff in, and why are they such a big deal to accountants? And isn’t there some weird voodoo where “debit” and “credit” don’t mean what a layman would expect them to mean?
[/QUOTE]

CPA chiming in here… I think the Debit/Credit concept won’t make as much sense if you are struggleing with the account concept. Scout gave a pretty good description of them, but I’ll add the nuance that it may help for you to think about them as recordkeeping, similar to Baseball Statistics.

Here’s a scenario for you:
A Batter gets a Hit for his team getting a home run. Their stats would be the Batter gets a “Hit” and the Pitcher gets tagged with a Run Given up.

So, in accounting terms:

Hitter's Account

Debit | Credit
___1

Picther’s Account
Debit | Credit
_________1

So each player has an account. And if you add all the accounts together for all the activities in a Game, you could call it the “Game’s Ledger” representing all the activity for that game. Also you can see where they offset each other (debits must equal credits).

Hopefully that analogy helps there.
P.S. Perhaps someone could help with fix my codeing for the leading spaces? Thanks! :smack:

20

I love it.