“It’s Accrual World”
Accrual basis accounting is based on the “Matching Principal” which means the goal is to match revenues and expenses in the same period.
In short, this means you record income when earned (regardless of whether or not it is paid) and you record expenses when incurred, not paid.
Most small businesses attempting to keep accrual basis books do not take this to the fullest extent of what is required under GAAP (Generally Accepted Accounting Principals). The post invoices to recognize income and track their receivables, and they post bills to record expenses and track payables. But they don’t accrue (eg) Payroll expenses at the end of each month, which is necessary under GAAP unless the pay period ends exactly on the last day of the month.
RevenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… Recognition
There are also revenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… recognition implications. RevenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… generally isn’t earned until the business has “performed” whatever their obligation is under their agreement. Just because the client agrees to the fees and you invoiceComing Soon to a Browser Near You! them, doesn’t mean that you’ve earned the money yet. For practical reasons and since most small businesses are not required to follow GAAP, small businesses will recognize revenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… when invoiced.
There are potentially going to be many other revenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… recognition implications depending on the industry. Software development has it’s own set of rules. The basic rule of revenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… recognition according to FASB ASC 606 – RevenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… from Contracts with Customers.
The simple rule is that you earn revenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… when you’ve performed your obligation(s) under the contractComing Soon to a Browser Near You! you have. If there is a built-in “progress” nature under the contractComing Soon to a Browser Near You! then you can earn part of the revenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… based on how “performance” is defined. In general, it has to be safe to say that the client would not be due back any part of the revenueThere are 5 major account types in a company’s Chart of Accounts: • Assets • Liabilities • Equity • Revenue • Expenses The first 3 make up the Balance… that is earned under any circumstances.
The trick to this is to spell out the obligations and any applicable timeline as explicitly as possible in your ContractComing Soon to a Browser Near You!.
Expense Accruals
Above we mentioned the example of accruing payroll. Another example would be loan interest. If the bank charges interest on the 20th of the month, you have 10 days worth of interest to accrue as of the last day of the month.
Any expense that is assessed periodically, but accrues daily needs to be accounted for as an accrual at the end of each month. Again this would be overkill for most small businesses, but it’s important to be aware of these implications should you need to prepare GAAP Basis financial reports.
Any recurring expenses should be set up with a recurring transaction (eg a Bill) that posts without a payment posting. Then as payments clear the bank, they are applied to that bill. This ensures the most accurate accrual basis books.
Accrual vs Cash Basis Implications
Accrual basis accounting is designed to give you a more accurate picture of how the business is performing. This is accomplished by better matching revenues with the expenses incurred to produce those revenues.
For example, on a cash basis if rent is paid late one month, there will be one month with $0 in rent expense leading to a higher net income, and then another month with twice the normal rent expense leading to a much lower net income for the month. The expenses aren’t matched properly. It costs exactly 1 month’s rent to run the business in any given month. Accrual basis accounting says, record the rent in the month incurred, regardless of when it was paid.
With most accounting software, this means you create a “Bill” on the first of the month to record the expense on that date for Accrual Basis Accounting purposes.
Cash basis accountingCash Basis Accounting means income and expenses are only recorded when paid.In the strictest sense, this means no accounts receivable and no accounts payable exist.In theory, this means you would… saves you the trouble of paying taxes on uncollected income, but it doesn’t give a clear picture of how the business is operating, because it leaves out uncollected income that was earned during that period and it also leaves out unpaid expenses that were incurred during the period.
