How to accrue for and record utility expenses
March 5, 2010
Calculate and record utility expense accrual. Sample journal entries.
In accounting, the matching principle states that expenses are to be matched with revenues. In practice this means that all expenses associated with generation of revenues within a month (quarter, year) should be included in the income statement in the same period as the revenues.
Accounting events are based on source documents. For example, receipt of inventory is supported by a packing slip or bill of lading. Accounting would use this document to record the inventory received.
Sometimes source documents are not available when a month is being closed. Examples of such source documents are utility bills not received by the time the month is closed. The reason may be that such utilities have billing cycles different from a calendar month. They may calculate cost of services provided from the 21st of the current month to the 20th of the following month.
Your company, however, still incurred utility expenses in the current month, even though you don't have a source document to support that. What can you do to match revenues with related expenses in such a case?
You can accrue for such expenses. An accrual (a liability accrual) means recording expenses incurred but unpaid by month (quarter, year) end.
In cases when no source document is available to support the amount of accrual, the accrual can be estimated based on history and other known information.
It is to be noted that not all companies are required to go through this process of accruing for expenses. All depends on individual circumstances of a company or management needs. Large public companies are to carry out such procedures to ensure their financial statements (prepared in accordance with US GAAP or other set of standards, based on accrual accounting) are presented fairly in all material respects. On the other hand, small private companies may not need to do that as they do not present their financials to external parties. In addition, the concept of materiality should be applied to each company. If you are not sure if your company needs to worry about accruals, consult with your accounting advisor / professional or management.
Let's look at an example and consider two scenarios. One is when a company can wait to receive all utility bills and the other one is when a company can't wait to get utility bills to close the month.
Suppose Company ABC has a manufacturing facility. Obviously, the facility has utilities connected to it. The utility companies (electricity, water, etc.) issue their bills (invoices) using the billing cycle from the 21st of the current month to the 20th of the following month. Thus, the current utility bills will not be received until the end of following month.
At the beginning of April 2010, Company ABC’s Accounting Department closes the month of March.
The Accounting Department processes utility bills on a timely basis and pays them within a week after receipt. Thus, the utility bills for the period from February 21 to March 20 were paid during March.
The utility bills for the period from March 21 to April 20 will not be received until after April 20. Still, Company ABC used utilities for the full month of March or 31 days. The utilities for the first 20 days were paid during March. The remaining 11 days (from the 21st to the 31st) remain unpaid as of March 31.
How to determine what the incurred, but unpaid utility expenses for those 11 days were (amount to accrue for)? There are two possible options, among others (note that an accrual is an estimate, and of course, a company can utilize other methods).