There are two commonly used methods of accounting - Cash Basis and the Accruals Basis. Understand the difference between accruals and reversals. Recap the earlier discussion we had on accruals and reversals and see the comparison between these two different but related accounting concepts. Understand how the action of accruing results in reversals subsequently in the accounting cycle.
There are two commonly used methods of accounting - Cash Basis and the Accruals Basis. In cash basis of accounting, income is recognized in books when it is received in cash, and expenses are offset when they are actually paid.
Contrary to Cash Basis Accounting, in Accrual Basis Accounting, financial items are accounted for when they are earned and deductions are claimed when expenses are incurred, irrespective of the actual cash flow. The Accrual accounting method measures the financial performance of a company by recognizing accounting events regardless of when corresponding cash transactions occur. Accrual follows the matching principle in which the revenues are matched (or offset) to expenses in the accounting period in which the transaction occurs rather than when payment is made (or received).
Accrual accounting is considered to be the standard accounting practice for most companies and is the most widely used accounting method in the automated accounting system. This method provides a more accurate picture of the company's current condition, but as all income and expenses need to be recognized based on their occurrence and matching, it is relatively complex when compared to cash accounting, which recognizes transactions only when there is an exchange of cash. The need for this method arose out of the increasing complexity of business transactions and investor demand for more timely and accurate financial information.
To help you understand this concept let’s look at an example. A company has sold merchandise on credit to a customer who is creditworthy and there is the absolute certainty that the payment will be received in the future. The company earns a profit of $500 on the total sales price of $2000. The accounting for this transaction will be different in the two methods. The revenue generated by the sale of the merchandise will only be recognized by the cash method when the money is received by the company which might happen next month or next year. However in the Accrual Method, the revenue will be recognized in the same period, an “Accounts Receivable” will be created to track future credit payments from the customer.
Based on the above discussion now let’s take a look at some accrual/deferral related concepts:
Accrued revenue is an asset, such as unpaid proceeds from a delivery of goods or services, when such income is earned and a related revenue item is recognized, while cash is to be received in a later period.
Accrued expense, in contrast, is a liability with an uncertain timing or amount, but where the uncertainty is not significant enough to qualify it as a provision.
As an accounting practice expense and revenue accruals are reversed in the next accounting period to prevent double-booking of expenses/revenues when they get settled in cash
At the beginning of each accounting period, there is an accounting practice to use reversing entries to cancel out the adjusting/accrual entries that were made to accrue revenues and expenses at the end of the previous accounting period. The use of Reversing Entries makes it easier to record subsequent transactions by eliminating the possibility of duplication.
Reversing entries are made on the first day of an accounting period in order to offset adjusting accrual/provision entries made in the previous accounting period.
Reversing entries are used to avoid the double booking of revenues or expenses when the accruals/provisions are settled in cash.
A reversing entry is linked to the original adjusting entry and is written by reversing the position of debits with credits and vice versa.
The net impact of Original Entry and Reversing Entry on the accounting books is always zero.
In Automated Accounting Systems, it is not possible to delete transactions once the posting has been made. In such systems reversals is the recommended way to correct the erroneous entries. An example is that one interface feed has been posted by mistake twice. This has inflated many income expense accounts. A reversing entry with opposite debit and credit amounts to all the impacted accounts will nullify the impact of the mistake.
GL - Different Accounting Methods
The accounting method refers to the rules a company follows in reporting revenues and expenses. Understand the two common systems of bookkeeping, single, and double-entry accounting systems. Learners will also understand the two most common accounting methods; cash and accrual methods of accounting and the advantages and disadvantages of using them.
For any company that has a large number of transactions, putting all the details in the general ledger is not feasible. Hence it needs to be supported by one or more subsidiary ledgers that provide details for accounts in the general ledger. Understand the concept of the subsidiary ledgers and control accounts.
In some of the ERP tools, there are more than 12 accounting periods in a financial year. This article discusses the concept of accounting calendar and accounting periods. Learn why different companies have different accounting periods. Understand some of the commonly used periods across different organizations and the definition & use of an adjustment period.
In this article, we will describe how to determine if an account needs adjustment entries due to the application of the matching concept. Learners will get a thorough understanding of the adjustment process and the nature of the adjustment entries. We will discuss the four types of adjustments resulting from unearned revenue, prepaid expenses, accrued expenses, and accrued revenue.
Shared Services is the centralization of service offering at one part of an organization or group sharing funding and resourcing. The providing department effectively becomes an internal service provider. The key is the idea of 'sharing' within an organization or group.
Five Core General Ledger Accounts
Typically, the accounts of the general ledger are sorted into five categories within a chart of accounts. Double-entry accounting uses five and only five account types to record all the transactions that can possibly be recorded in any accounting system. These five accounts are the basis for any accounting system, whether it is a manual or an automated accounting system. These five categories are assets, liabilities, owner's equity, revenue, and expenses.
After reading this article the learner should be able to understand the meaning of intercompany and different types of intercompany transactions that can occur. Understand why intercompany transactions are addressed when preparing consolidated financial statements, differentiate between upstream and downstream intercompany transactions, and understand the concept of intercompany reconciliations.
Introduction to Legal Entities Concept
Modern business organizations operate globally and leverage a large number of registered legal entities, and operate through complex matrix relationships. To stay competitive in the current global business environment, they must often develop highly diverse and complex organizational structures that cross international borders. Learn more about Legal Entities and their importance for businesses.
GL - Different Type of Journals
Two basic types of journals exist: general and special. In this article, the learner will understand the meaning of journalizing and the steps required to create a journal entry. This article will also discuss the types of journals and will help you understand general journals & special journals. In the end, we will explain the impact of automated ERPs on the Journalizing Process.
Period End Accruals, Receipt Accruals, Paid Time-Off Accruals, AP Accruals, Revenue Based Cost Accruals, Perpetual Accruals, Inventory Accruals, Accruals Write Off, PO Receipt Accrual, Cost Accrual, etc. are some of the most complex and generally misconstrued terms in the context of general ledger accounting. In this article, we will explore what is the concept of accrual and how it impacts general ledger accounting.
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