Periodic accruals of annual expenditures

December 15, 2015

This articles talks about one way (among others) to perform periodic accrual of annual (quarterly, etc.) expenditures.

1. Matching revenues and expenses

According to the accrual based accounting rules, revenues should be matched with expenses and expenses need to be recorded when they are incurred.

This is done to ensure proper presentation of financial statements of a company.† In particular, a company should reflect a cost of services or goods received in the period when such receipt takes place (note: there are exceptions).

This is the accrual accounting side of business.† The cash side of it (cash payments for services or goods received) is usually different in a way that cash outflows take place later in the purchase cycle.† For example, a company can receive services every month and only pay quarterly or annually.

(It is quite possible that the opposite situation takes place: a payment is made in advance of receiving services or goods.† This type of transactions results in accounting deferrals.)

Even though payments for goods and services may be postponed, the cost of such goods and services received should be recorded in the period when such receipt takes place.† This is done by utilizing accruals.

2. Example of periodic accruals of annual expenditures

There may be a few ways to handle a situation of accruing for an expenditure before the payment is made.† A lot depends on company preferences, accounting system capabilities, etc.

We will concentrate on receipts of services here as they are more typical when we talk about accruals.† We will also present one of the options which may or may not work in all cases.

Generally, regardless of the method used to account for accruals, each period (e.g., month) should have a portion of the quarterly (or annual) expenditure associated with that period.

For example, letís assume that a company subscribed for a phone service.† The service agreement is for a year and payments are to be done quarterly in equal amounts (25% of the annual amount).† The annual service fee is $24,000.† The quarterly payment is $6,000 and the monthly amount is $2,000.

One of the ways to properly account for such accruals is to record a monthly reversing journal entry.† For the first month, the entry amount will be $2,000.† It will reverse at the beginning of the second month.† At the end of the second month, the entry amount for the accrual will be $4,000.† It will reverse at the beginning of the third month.† At the end of the third month, the entry amount for the accrual will be $6,000; provided, the company doesnít make the quarterly payment until the fourth month.† In case the company makes the quarterly payment during the third month, no accrual entry ($6,000) would be required and only the payment amount would be recorded as an expense.

In our example, the journal entries would look as follows:

Month 1

To record accrual of phone service expense for the first month:

Account Names

Debits

Credits

Phone Service Expense

2,000

 

      Accrued Expenses

 

2,000

Month 2

To reverse the first month accrual (usually done by accounting systems automatically):

Account Names

Debits

Credits

Accrued Expenses

2,000

 

      Phone Service Expense

 

2,000

To record the accrual of phone service expense for the first and second months:

Account Names

Debits

Credits

Phone Service Expense

4,000

 

      Accrued Expenses

 

4,000

Month 3

To reverse the first and second month accrual (usually done by accounting systems automatically):

Account Names

Debits

Credits

Accrued Expenses

4,000

 

      Phone Service Expense

 

4,000

To record the accrual of phone service expense for the first, second and third months:

Account Names

Debits

Credits

Phone Service Expense

6,000

 

       Accrued Expenses

 

6,000

Month 4

To reverse the first, second and third month accrual (usually done by accounting systems automatically):

Account Names

Debits

Credits

Accrued Expenses

6,000

 

      Phone Service Expense

 

6,000

To record a quarterly payment for the first, second and third month:

Account Names

Debits

Credits

Phone Service Expense

6,000

 

      Cash/Accounts Payable

 

6,000

If the company makes the quarterly payment during the third month instead of the fourth month, then there would not be entries noted for Month 4 above and instead of the second entry for Month 3, the following journal entry will be recorded:

To record a quarterly payment for the first, second and third month:

Account Names

Debits

Credits

Phone Service Expense

6,000

 

      Cash/Accounts Payable

 

6,000

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