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WHAT ARE ACCRUALS?
In your mind you calculated sales invoices €10,000, I have received purchase invoices of €6,000 so I made a profit of €4,000. Ahh but John has not sent me his invoice for €2,000, so my real profit is only €2,000. This is accruals. Taking into account costs you have been billed yet Accruals are costs that you charge in your profit & loss account even though you may not have received an invoice for them yet.
A typical example is your audit or accountancy fee you receive from your auditor or accountant. The auditor prepares accounts for 31st December 2006, but you don’t get billed until 2007 for the work. But the work relates to 2006 accounts, so we must make an estimate if we don’t know the exact amount for the accrual and put a charge into the 2006 accounts.
If your supplier is always late in sending purchase invoices to you, the purchase costs in your profit & loss account will be understated in one month and over stated when you receive the invoice in the next month. So we must accrue for the invoice not received yet. If we were sent 1000 widgets (that cost €1 each) in June, but did not get the invoice until July we must accrue for a cost (the invoice not received) of €1,000, otherwise we will have stock worth €1,000 and no cost for them.
EXAMPLE OF ACCRUALS:
| Sales | 22,000 | 11,000 widgets x €2 | | | Purchases | 11,000 | 12,000 widgets x €1 | | | Less closing stock | -1,000 | 1,000 widgets x €1 | | | Cost of Sales | 10,000 | | | | Profit | 12,000 | | | | Sales Margin | 54.45% | 12,000/22,000 | | | Mark up | 120% | 12,000/10,000 | | So in this example we have a purchases value of only €11,000 but we received 12,000 widgets. Our purchases are understated by €1,000 and our profit is overstated by €1,000. Our Sales Margin is wrong and our Markup is wrong
So how do we fix this using an accrual?
| Sales | 22,000 | 11,000 widgets x €2 | | Purchases | 11,000 | 12,000 widgets x €1 | | Purchases Accrual | 1,000 | | | Total Purchases | 12,000 | | | Less closing stock | -1,000 | 1,000 widgets x €1 | | Cost of Sales | 11,000 | | | Profit | 11,000 | | | Sales Margin | 50% | 11,000/22,000 | | Mark up | 100% | 11,000/11,000 | | | | | | | | | Now our Profit & Loss a/c is correct. Our margins and markup are as expected
So accruals are used to match costs with sales. The goods sold in the month are matched to the costs for that month, with any missing costs being accrued for.
What about next month?
When the invoice comes in for the goods next month we will take into account that there was an accrual and ensure that the accrual is matched against the invoice so it is not double counted.
article:100018 (c) Nilsson Denver Ltd 2007 |
