At the end of each accounting period, all accrued liabilities are adjusted on the balance sheet to provide documentation for goods delivered and services performed that have not yet been billed. Accounts payable accruals are a specific type of accrual liabilities that fall into that last category.
These transactions are generally periodic and related to goods and services provided by your vendors, as well as general business operations. Wages payable and other liabilities like loan payments fall outside this category of accrued expenses. At the end of a given accounting period usually the fiscal year , all accrued expenses for that period must appear on the balance sheet, along with all the income your company has received.
The proper journal entries must be prepared to reflect the actual date the expense was incurred in order for your balance sheet and other financial documents to be accurate and complete. When payment is made in March, additional journal entries adjustment entries will be added to reconcile the outstanding AP accrual. In this way, the financial statements for both and are complete and accurate, with a clear connection between the actual receipt of the computers and the date they were actually paid for by your company.
Doing so helps ensure you can record accrued expenses for the proper tax period, for example. For both your long-term and current liabilities, implementing advanced digital tools like PLANERGY—either as a complete AP automation solution, or in tandem with existing accounting software—gives you greater transparency and control. Your busiest sales period might run from early November to early December.
Accrual accounting would reflect that: It would show you earning the bulk of your revenue in that period. But you might not receive payment from the street vendors until later, in January. Under cash accounting, your busiest period would appear -- incorrectly -- to be January.
By requiring businesses to book revenue when earned and expenses when incurred, GAAP aims to prevent companies from misrepresenting their business activity by manipulating the timing of cash flows. Under cash accounting, a business could avoid recording a loss for, say, the month of June simply by holding off on paying its bills until July 1.
If September looks like it's going to be a weak month for sales, a company could prop up the numbers by delaying the billing of some customers so that their payment doesn't arrive until after Sept.
With accrual accounting, a company hoping to manipulate its numbers like this would have to lie about the timing of revenue and expenses -- in other words, to commit fraud. Any business owner knows that you don't pay your bills with "revenue. That's why GAAP calls for a business to produce regular cash flow statements, which track cash coming into and out of the business, separate from the revenue and expenses that get booked on the income statement. Combined, the income and cash flow statements present a full picture of when the company earns its money and when it gets its money.
Thus, the conversion is both labor intensive and expensive. In fact, if a firm has qualified accounting personnel, it may be prudent to adapt the accrual method to begin with. Most accounting software, such as QuickBooks, supports both cash and accrual methods of accounting, and even allows users to create cash and accrual financial statements at the same time. However, management should still research different accounting software providers to ensure the software supports the method management desires to employ.
If your firm decides to use cash accounting from the onset, make sure to keep detailed records for all transactions, as it is often the only way to ensure an accurate and complete conversion process when you decide to switch to the accrual method. Cash and accrual accounting methods are both common in practice; thus, startups should understand their advantages and disadvantages, and choose the method best suited to their company based on both short- and long-term business objectives and strategies.
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Jason grew up in Taiwan and have lived in Washington D. He is studying accounting, information systems, and music. Outside of accounting and writing, he is a classical music geek and a food enthusiast who prefers mozzarella with Mozart and ravioli with Ravel.
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