My name is Steve Chen, a fellow member of ACCA and course director at APC (www.globalapc.com), teaching ACCA online courses to students from all around the world. This article will explain the concept of accruals in your ACCA Financial Accounting Papers.
Suppose the business has used electricity in the recent three months but has not received the invoice from the electricity company as at the Financial Statements year end. Should the business recognise electricity expenses or not?
The answer is yes because the business needs to match the income earned with expenses, to calculate profits or losses. Without electricity, the business may not have produced and sold those high-quality products.
Hence, even if the business has not paid for electricity expenses, the business still needs to account for those expenses to reflect that the electricity has been used. This is known as ‘accruals’ or ‘matching’ concept.
Other examples of accruals include:
Example one: invoice is due:
The business has not paid the invoice from the supplier for the use of electricity as at the year end, although the invoice is due. If we have received the invoice from the electricity supplier but we have not paid it yet, we do need to provide for an electricity expense and liability to reflect the fact we owe money to the supplier.
Example two: depreciation
Depreciation expense for the non-current assets which must be provided for. This is because when the non-current asset is used in the daily business operations—such as machinery—these machineries are likely to become less and less efficient as time passes.
From the accounting’s point of view, we do need to write down the machinery’s value, but the value written down will be very subjective, i.e., according to our judgement. The depreciation expense will never be settled in cash, and this is just an accounting adjustment, i.e., to artificially match the income the business generates from using the machinery to the expense we think it may have incurred.
Example three: unsold inventories
Unsold inventories need to reduce the costs of sales. Costs of unsold inventories should not be recognised as the cost of sales because we only match the costs of those sold inventories with their associated income.
Example four: income tax estimate
The estimate of income tax expense for the current period should be provided for. This is to match the income the business generates in the current period, with the estimated tax expense to calculate the net profit.
In addition to providing ACCA lectures online, I also wrote articles in ACCA AB magazine. Besides, I am the author of four accounting books. If you are interested in studying ACCA courses with me, please visit my website http://www.globalapc.com for further information, where you can find many of my ACCA demo video lectures.