brief guide to Accruals Accounting

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					   A Brief Guide to….

Accruals Accounting




     November 2005 DRAFT v.1.0
v. 1.0 - November 2005                                           Document: briefguide_accruals.doc


                     Accruals Accounting
                     Accruals Accounting is about ensuring that all income and
                     charges relating to a financial period are actually
                     recorded as being part of that period – and that assets
                     and liabilities are appropriately disclosed.

               This means amounts are recognised when they are
               incurred, or when the right to receive them arrives –
regardless of the actual date of any cash receipt or payment.

It also requires that ‘non-cash’ transactions and events are recognised
in the accounts to give ‘the complete picture’ – this includes concepts
such as depreciation and provisions - as covered in the table opposite.

Cash Accounting - An Alternative?
In terms of conveying a ‘true and fair view’, there isn’t really any
alternative to accruals accounting. Worldwide accounting standards are
clear in that accruals accounting is “part of the bedrock of accounting”

 “An entity shall prepare its financial statements, except for
 cash flow information, using the accrual basis of accounting.”
 International Accounting Standards, IAS1 s.25 & Financial Reporting Standards, FRS 18 s.26


The old approach of ‘Cash Accounting’ shows just cash receipts and
cash payments when they occur. There are no adjustments made to
reflect amounts owed or owing – or the ownership and use of assets.
Whilst this has simplicity to offer, it does not provide the complete
picture and is only appropriate today for the very smallest of
organisations – typically very small-scale voluntary groups with low
levels of stakeholder interest.

                         The Cash Flow Statement
                         With Accruals Accounting comes the need for a Cash
                         Flow Statement which takes equal importance alongside
                         the income statement and balance sheet in the accounts.

                         This is necessary because a focus on cash remains an
                         important measure of business health and operation.


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To achieve this, the Cash Flow Statement follows a
standard format to show cash flows during the period -
analysing them between operating, investing and
financing activities – and providing a reconciliation of the
change in cash balances during the period to the
difference between income and expenditure in the income
statement.

Fundamental Concepts
Accruals Accounting brings with it the need to consider and include;

 Accrued           Anticipation of future payment requests whereby you have received
 Expenses          goods or services – but have not yet been charged for them. These
                   show as the type of expense they are (e.g. Electricity) on the
                   Income Statement and as an ‘Accrued Expense’ Liability on the
                   Balance Sheet.
 Creditors         A Balance Sheet liability showing amounts you owe for goods and
                   services received that have been invoiced, but not yet paid.
 Debtors      A Balance Sheet asset showing amounts owed to you for goods and
              services delivered but not yet been paid for.
 Depreciation Assets don’t last forever. Depreciation is a prudent estimate of the
              cost of tangible fixed assets that you have used in the period – a
              valid (but ‘non-cash’) expense charged to the Income Statement –
              and a reduction in asset value in the Balance Sheet.
 Prepayments An asset in the Balance Sheet recognising that you have paid for
              something that relates to the next accounting period (and therefore
              is not shown in the Income Statement). For example, if an annual
              software licence is paid in January for the calendar year, there
              would be a ‘prepayment’ in the March 31st Balance Sheet for 9
              months worth of the total cost – and the Income Statement would
              only show the 3 month ‘true cost for the period’.
 Provisions   Typically relating to ‘bad debts’ – It is prudent to assume not all
              debts owed will be collected – and a ‘Provision for Bad Debts’
              charge to the Income Statement may be appropriate to present a
              ‘true and fair’ view – with a corresponding liability balance on the
              Balance Sheet.
                   There is also the possibility of a contingent asset or
                   liability – where at the Balance Sheet date, a
                   potential   asset     or    liability exists  –   but
                   materialization of such is out of Management’s
                   control – for example, the outcome of legal action
                   where, on the balance of probability Management
                   may need to pay a damage settlement – would call
                   for a contingent liability on the Balance Sheet.


A brief guide to…. Accruals Accounting                                                     Page 3
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           Accepted reasons behind Accruals Accounting
       Gives the complete ‘true and fair’ picture with all income and costs related
       to a period being put to that period – & all assets and liabilities recognised.
       Performance easier to measure with revenues earned compared to
       resources consumed in a period – rather than simply cash in and cash out.
       Improves comparability from one period to the next.
       Enables long-term financial management and decision making.
       Makes clear the true cost of goods / services provided.
       Forces full records of assets & liabilities – improving management of them
       and showing the cost of using up assets and planning for their replacement.
       Reveals if current activities are funded by running down net worth.
       Recognises cost of future payments – e.g. pension commitments.
       Reduces potential for manipulation of accounts.

            Cash vs. Accruals Accounting – A Simple Example
Imagine you’ve built and sold a house during the year. It cost you £10,000 to
build – and you’ve done all the hard work to get a legally agreed sale for £30,000
– which at the accounting period end remains due but unpaid.
On a cash accounting basis, your Income Statement would say you’ve lost
£10,000 over the period. On an accruals basis, your Income Statement would say
you’ve made £20,000. A fundamental and worrying difference!
Which is the ‘true and fair’ view??

                                         Still unconvinced?
Try and answer these questions with ‘cash accounting’;
   •   You had a £10,000 budget for the year. Have you kept within it?
   •   How much does the organisation owe?
   •   What are its main assets – and how much value is left in them?
   •   Is the organisation a viable ‘going concern’ to survive in the future?
The simple answer is that, with ‘cash accounting’ you can’t.
This should be a grave concern and warning to all those interested in
organisations that still use ‘cash accounting’ instead of ‘accruals accounting’.




                Document Prepared By: St Helena Government Audit Department

                                   chief.auditor@sainthelena.gov.sh
                                                     (00 290) 2111



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