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The idea of accrual accounting can be intimidating, even for bookkeepers who have years of experience.
This may be because accrual accounting requires more knowledge of the overall picture of a company, it’s goals, it’s management direction, and the full story behind every deposit, expense, and liability.
Whereas with cash accounting, all this knowledge is not necessarily needed. To help ease our minds about accrual accounting, here are 5 stereotypes that are not always true.
1. It doesn’t make a difference on your financials
The accrual method allows a bookkeeper to show expenses and revenue as they are earned, as opposed to when funds are transacted.
This method has an overall effect on both the income statement and the balance sheet.
Let’s say ABC Company provides a service on January 15th, but bills for the service on February 1st, on Net 90 payment terms.
So ABC Company really wouldn’t get paid until May 1st. On a cash basis accounting method, ABC Company’s revenue for this project would be booked May 1st.
But under accrual accounting, revenue would be booked January 15th, when it was earned.
In this scenario, if the owner of ABC Company was looking at the profit & loss statement for January and using the cash method, they would not see income for that month for this project.
However, with the accrual method, when the business owner looks at the profit & loss statement for January they would see that the company has income (or earned revenue) on the project.
Since financial decisions are best made after reviewing financial statements, we can say the financial statements are pretty impacted by accrual accounting.
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2. It takes the same amount of time as cash accounting
As discussed, accrual accounting calls for the revenue to be recorded when incurred.
Now, when booking that revenue in double-entry bookkeeping, the other side of the entry would be a receivables account debit, an asset account.
However, when the company actually receives the check, for example when ABC Company finally deposits the check payment for their project on May 1st, their bookkeeper would then credit accounts receivable and debit (increase) cash.
Do you notice how in accrual accounting there are actually 2 entries to make for the 1 business transaction?
Once when income is earned, and again when income is actually received.
Whereas with cash basis accounting, there is only entry to make: when funds are received.
You could say based on this example that accrual accounting takes twice the amount of time. Two entries versus one entry.
Of course, this is not the rule of thumb across the board. The speed and ease of executing accrual accounting will depend on the experience and knowledge of the bookkeeper.
If you are thinking of hiring a bookkeeper who knows about accrual accounting, perhaps an online bookkeeping company, you will want to make sure they know what they are doing.
A great choice would be Akuracy.
As far as the stereotype goes, accrual accounting can take more time than cash accounting because of the extra entries to be made at month-end and year-end.
3. Accrual accounting is only for large companies
This comes down to the reason why a company would want to use accrual accounting versus cash accounting.
Is it only large companies who’d want to use it? Accrual accounting is a strategic choice because you get to see more clearly the company’s performance in terms of operations.
As you can imagine, accrual accounting provides consistency on the books.
Monthly expenses such as insurance, rent, employee benefits, and company car lease payments, would need to be accrued, booked monthly, one time each month.
In cash accounting, sometimes things can end up being booked twice in one month.
For instance, if ABC Company paid rent on January 1st, and again on January 31st for February, on a cash basis they would show two rent payments in January, and no rent payments in February.
Accrual basis keeps thing consistent because you are accruing the expense manually once a month and no more. What is the advantage of showing expenses consistently?
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In fact, if a company is looking to raise funding from investors, accrual basis better shows on the financials what a company’s monthly expenses are.
Perhaps that company looking to raise money is a small startup, so they opt for the accrual method. Stereotype busted!
4. You can only do it on specialized softwares
Even though accrual accounting isn’t rocket science, it does require knowledge and skill in terms of bookkeeping.
Does that mean it also requires specialized online bookkeeping software? You may be surprised that most accounting softwares can accommodate accrual accounting.
Internet-based accounting softwares such as Quickbooks, Xero, and Sage come with the capability to make manual journal entries, which is a requirement for accrual accounting.
What is more, some online bookkeeping softwares come with the ability to set up a recurring automatic monthly journal entries for you.
Then you don’t have to make it manually each month. Super convenient right?
5. It allows you to be less organized
This stereotype might be a bit laughable.
The thought of being unorganized where accounting is concerned is out of the question and usually the farthest thing from a business owner’s mind.
It’s always surprising how many short cuts some are willing to take. On the other hand, it’s understandable because let’s face it, who has extra time to be meticulous?
I will say this. While it is not encouraged to be unorganized (ever!), where your books are concerned, there are a couple things you can do today to save yourself time sorting things out later.
Organize your G/L. Look at your recurring business expenses. For example, you may have Google gmails for your company domain. Or perhaps, that Docusign monthly fee.
When booking these expenses and using accrual accounting, instead of throwing them all into one “Office Expenses” general ledger account, create a sub G/L account under Office Expenses for each of them.
So in this example you’d name them “Office Expenses – Emails”, “Office Expenses – Docusign”, etc.
And each time you have to book the Gmail expense and Docusign expense, book them to their own G/L’s.
Now for items you don’t want to separate out or that aren’t as consistent, you can create an “Office Expenses – Other” account.
Then when you’re looking at the financials you can easily tell what type of office expenses are costing you the most money.
You can use this strategy with any type of expense account.
And then when you do your monthly accrual entries, you book them to the pre-specified named accounts, and you don’t have to divvy them up later.
- Pay close attention not to make mistakes! Human error can be detrimental to your books. If you’re careless and inconsistent, the financials may not portray the best picture they were meant to portray. Not to mention, fixing mistakes can take you twice as long if not longer to correct. More time than you’d spend booking carefully and double checking your work in the first place.
Yes, these two tips can help save you time in accrual accounting. Although there are many more Bookkeeping Tips that can help keep your books clean and effective.
When all is said and done, accrual accounting can be an excellent way to see a business’ activity.
Particularly for businesses who need to see what they’ve made and spent per project before actually getting paid for it, and who are looking for investors.
So don’t shy away from accrual accounting because of a few stereotypes, if it’s what your business really needs.