Over the next few weeks we’ll be posting a series of blogs on some more complex areas of accounting that you may be exposed to. Today, we’ll talk about common accruals and how you post them.
Our students are very family with accruals, but for those non-students reading this post, remember, accrued liabilities are expenses that have been incurred by a company as of the end of an accounting period, but the company has not yet received a bill or invoice for them.
You can also have accruals on the revenue or income side – these are revenues that have been earned as of the end of the accounting period, but have not yet been invoiced.
We’ll focus on accrued liabilities, as these are common across most companies and it is very likely you’ll start seeing these when you begin working in an entry-level role.
There are some expenses that need to be accrued for in most companies at the end of every month:
- Audit fees:
Many companies and not-for-profit organizations need an audit at the end of every fiscal year. However, auditors typically complete their work after the year-end and do not send their invoices until the work has been completed. For example, for the 2019 year (running 1 January to 31 December 2019), your auditors will typically complete their work in February or March 2020, and will not send you an invoice until March or April 2020. Even though we don’t receive an invoice from the auditors every month, we need to record the audit expense evenly over the year. In this case, an accrued liability is required each month, in the amount of 1/12 of the expected audit fee. By the end of the year, you should have an accrual for the total fee to be paid. For example, if your auditors charge $6,000 for the annual audit, you should accrue $500 each month. At the end of the year, you’ll have an accrued liability of $6,000 (12 months x $500).
Because utility bills are often based on usage, the service provider often does not provide an invoice until after the period is over and they can calculate the charge. In this case, you need to make an estimate, usually based on past bills and expected usage, and post the expense and related accrued liability for that amount. For example, if your water bills for December, January and February were 151,220, 176,000 and 143,780, for March you could accrue 157,000, the average of the three previous months.
- Internet and telephone charges:
Many internet providers and telecoms do not provide their invoices until the first or second week of the next month. For example, for internet used in March 2019, you might receive your invoice on 9 April 2019. In this case, the internet has been used in March, so it is a March expense and needs to be recorded in March, even without an invoice. If you have a fixed contract, the internet bill may be the same every month, or it may vary based on usage. In either case, you must make your best estimate and record the expense and related accrued liability.
- Payroll taxes:
Although salaries are usually paid out to all employees by the end of the month, the related payroll taxes (PAYE, social security, pension) are usually not paid until the next month (for example in Kenya, these are due by the 9th of the following month, in Rwanda by the 15th). At the end of each month, you need to calculate the amount due to the tax authority and record the expense and related accrual. These amounts should match exactly to the declarations you submit to the tax authorities.
How to post accruals
So, how do we actually post accruals to our accounting system? Each company’s process will vary slightly, but here’s the general process:
- Calculate the amount of each type of accrual. You should maintain a list of your company’s accruals so that each month no accrual is missed.
- Draft your journal entries. Your entries should be dated as the last date of the month. The typical general entry to post is:
Dr. Expense (internet, utilities, audit)
Cr. Accrued liabilities
- Reverse your accrual. Because your accrual is just an estimate at month-end, you should reverse the accrual once you receive the invoice that you accrued for. The typical entries would be:
Dr. Accrued liabilities
Cr. Expense (internet, utilities, audit)
Dr. Expense (internet, utilities, audit)
Cr. Accounts payable
Let’s look at an example to make sure the journal entries are clear. In this case, we have post-paid airtime, invoiced by MTN. Typically, the bill is about Rwf 450,000 each month and we receive it on the 7th of the next month. For the month of March, we receive our bill on 10 April and it amounts to Rwf 465,800.
Dr. Telephone expense 450,000
Cr. Accrued liabilities 450,000
Dr. Accrued liabilities 450,000
Cr. Telephone expense 450,000
Dr. Telephone expense 465,800
Cr. Accounts payable 465,800
Each company will have a slightly different process, so talk to your manager before you start posting any accruals. Make sure you thoroughly understand the process before drafting or posting any entries. It’s always best to ask questions first, instead of making mistakes that your manager will find later!