GL - Accruals and Reversals

GL - Accruals and Reversals

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.

What is Accounting Accruals:

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

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.

Accrual - Example

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.

Accrual Concepts

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

Concept of Reversals:

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.

Related Links

Creation Date Tuesday, 30 November -0001 Hits 69637

You May Also Like

  • Horizontal or Flat Organizational Structures

    Horizontal or Flat Organizational Structures

    Flat organizational structure is an organizational model with relatively few or no levels of middle management between the executives and the frontline employees.  Its goal is to have as little hierarchy as possible between management and staff level employees. In a flat organizational structure, employees have increased involvement in the decision-making process.

  • Benefits of Automated GLs

    Benefits of Automated GLs

    The general ledger is the central repository of all accounting information in an automated accounting world. Summarized data from various sub-ledgers are posted to GL that eventually helps in the creation of financial reports. Read more to understand the role and benefits of an effective general ledger system in automated accounting systems and ERPs. 

  • Five Core General Ledger Accounts

    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.

  • Partnership Form

    Partnership Form

    When the quantum of business is expected to be moderate and the entrepreneur desires that the risk involved in the operation be shared, he or she may prefer a partnership. A partnership comes into existence when two or more persons agree to share the profits of a business, which they run together.

  • GL - Accrual Basis Accounting

    GL - Accrual Basis Accounting

    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.

  • Shared Services Model

    Shared Services Model

    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. 

  • GL - Journal Entry & Import

    GL - Journal Entry & Import

    This article explains the process of entering and importing general ledger journals in automated accounting systems. Learn about the basic validations that must happen before the accounting data can be imported from any internal or external sub-system to the general ledger. Finally, understand what we mean by importing in detail or in summary.

  • GL - Account Allocations

    GL - Account Allocations

    An allocation is a process of shifting overhead costs to cost objects, using a rational basis of allotment. Understand what is the meaning of allocation in the accounting context and how defining mass allocations simplifies the process of allocating overheads to various accounting segments. Explore types of allocations and see some practical examples of mass allocations in real business situations.

  • GL - Using Adjustment Period

    GL - Using Adjustment Period

    In most of the automated financial systems, you can define more than 12 accounting periods in a financial year.  This article will explain the concept of the adjustment period and the benefits of having adjustment periods. Adjustment periods have their inherent challenges for the users of financial statements and there is a workaround for those who don’t want to use adjustment periods.

  • Operational Structures in Business

    Operational Structures in Business

    Large organizations grow through subsidiaries, joint ventures, multiple divisions and departments along with mergers and acquisitions. Leaders of these organizations typically want to analyze the business based on operational structures such as industries, functions, consumers, or product lines.

Explore Our Free Training Articles or
Sign Up to Start With Our eLearning Courses

Subscribe to Our Newsletter


© 2023 TechnoFunc, All Rights Reserved