As discussed in our previous post, the journal entries required for accruals are quite simple.
The purpose of an accrual is to recognize an expense before the invoice has been received and to recognize a creditor balance on the balance sheet relating to this expense.
Since accruals are actually classed as creditors on the balance sheet we can meet all of the above requirements by posting one simple journal.
The journal entry for accruals is as follows:
- Dr Expense Account (P&L)
- Cr Accruals (Balance Sheet)
The debit side of this journal increases the expense account balance (i.e. it recognizes the expense in the income statement).
The credit side of this journal increases the accruals balance on the balance sheet. Since accruals are classed as a creditors, this allows us to show that there is money owed for the expense but we are waiting to be billed.
What happens when the invoice is received?
When the invoice is received from the supplier, it is time to recognize the actual creditor balance on the balance sheet which means removing the original accrual balance.
To do this we post the following journal:
- Dr Accruals
- Cr Trade Payables
By debiting the accruals with the same value as the original amount, we offset the initial credit thus making the net value of the accrual zero. The credit entry to trade payables allows us to show that there is an amount owed to a specific supplier on the balance sheet.
Example
To put what we have just learned into practice, we will look at a simple example and post the journal entries for accruals.
XYZ Limited have used £1,000 worth of electricity which is supplied by Energy Limited. At the year end of 31st July 2020, no invoice had been received for this electricity.
The scenario above is a classic scenario requiring the entry of an accrual.
Let’s start with the initial entry where we recognize the expense. We know that £1,000 worth of electricity was used in the year and therefore we must put this into our profit and loss account. The other side of this entry will be the credit to recognize the balance sheet liability (which for now will be an accrual).
The entry for this would be as follows:
- Dr Electricity Expenses £1,000
- Cr (Electricity) Accrual £1,000
At the year end we have now accounted for the item appropriately and no further action needs to be taken.
Let’s imagine that one month later, Energy Limited send the invoice for the electricity used and it is now time to put the balance on the creditors ledger. No entry is required to the profit and loss account since we already accounted for the expense in the correct period (before the year end)
We simply need to re-class the accrual to trade payables with the following entry:
- Dr (Electricity) Accrual £1,000
- Cr Trade Payables £1,000
Now, if we look at the net effect on all of the accounts we can see that:
£1,000 of electricity expenses were recognized in the correct period.
£1,000 of trade payables to energy limited has been recognized in the period that the invoice became due.
and also that there is £0 still sat in the accruals account at year end which is exactly what we wanted to happen.
Summary
In summary, the journal entries required for accruals are simple once you understand the basic principles and they help accountants to show the true expense/liability figures within each accounting period.
