Accruals

Accrued expenses

An accrual occurs when an expense has been incurred and should be charged against profit in the current year but for some reason by the time the accounts are drawn up, that expense has not been included in the trial balance. This could be because the business has received the benefit of goods or services, but has not received an invoice for them.

Making an adjustment in this way complies with the accruals concept referred to above, because if an adjustment is not made for an accrual then the accounts will not be giving a true reflection of the position of the business for that year. The business will have had the benefit of something but not yet paid for it. Therefore, the profit of the business will be shown as artificially high unless the adjustment is made.

Dual effect of accruals

Accruals are recorded in an expense account and a liability account:

• Expense: The relevant expense account is adjusted (in an upwards direction) so that it records the correct amount of goods, services (or other ‘benefit’) used in the accounting period.
• Liability: A liability account is created, as the business has not yet paid the amount accrued and so we cannot reduce any asset directly. The liability account shows the business is liable to pay the amount of the accrual. All accruals are added together and shown in a single liability account (labelled ‘Accruals’).

Accruals year-end adjustment

When you are given a preliminary trial balance:

1. the relevant expense account will show the balance on the account before taking into account the accrual; and
2. there will be no accruals current liability account for the year in the list of account balances.

To make the year-end adjustment for accruals, you should therefore :

1. add the amount of the accrual/accrued expense to the expense account for that item in the trial balance. The increased expense figure will be included in the profit & loss account; and
2. include the amount of the accrual as a current liability in the balance sheet.

Example
Town & County Auctioneers (‘TC’) recently moved to new premises and used the services of its solicitors, to act on its behalf for the purchase of the new property. The preliminary trial balance includes a balance of £6,500 in the Legal Fees account, which were fees that the company was billed for and has paid.

At the year end, TC has not yet received a bill of costs for some of the work done by the solicitors a month ago. The bill is expected to be for £500.

The trial balance shows that TC has used £6,500 of legal advice in the accounting year when really it has used £7,000 (i.e. £6,500 + £500) of legal advice.

The figure of £7,000 (including the £500 which TC has not yet paid for) must be included in the Legal Fees expense account and shown in the Profit and Loss Account.

The £500 which Panache owes must be included as an Accrual current liability account, and shown on the Balance Sheet.