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Accruals, Essay Example

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Words: 607

Essay

An important accounting concept that I learned on the job is the concept of accruals. According to The Free Dictionary, the exact definition of an accrual is “Accounting a charge incurred in one accounting period that has not been paid by the end of it” (thefreedictionary.com, n.d.). Accruals are found on the balance sheet and represent both liabilities and non-cash based assets in management accounting. The types of accounts that can fall under this category are future interest expense, future tax liability, goodwill, accounts receivable, and accounts payable.

Accruals have several definitions and purposes in the business world. Firstly, it is important to note that there is a difference between accrued revenue and accrued expense. Accrued revenue is defined as an asset and usually includes unpaid proceeds from delivery of goods or services; in this situation, the income earned is recognized by the physical cash is received at a later point in time. Accrued expense is defined as a liability in which the timing or amount that will be earned is uncertain due to the fact that the company has not yet received an invoice. This is usually the case when a good or service is provided but not billed until a future accounting period.

In addition to these two aforementioned types of accrual, accrual occasionally has a place in employee payroll. When employees have vacation or sick accrual, they are accumulating additional time off and the money that represents their time is placed into a special bank account. Once the time itself is accumulated by the employee, the manager will then use this money to compensate their sick or vacation leave.

There are several ethical considerations that should be made when participating in accrual accounting. A common practice in fraudulent accounting is the use of accruals because it is easy to either lose track of the money that has not yet been paid or to change the numbers in the books to reflect higher profits by taking advantage of the way that accruals are organized. In a specific example, I have a friend who company has had old accruals stored on the balance sheet. She was unsure whether she should release them into the P & L without providing any disclosure in the notes that would be given to the accountants. She knew that they needed to be released at some point if she didn’t receive the bills, but was worried that doing so would inflate profit by a considerable margin.

In response, her manager told her that she should release the accruals because there was no justification as to why they were sitting there in the first place. The only situation in which they shouldn’t be released is if she was able to find enough evidence to audit; this can occur either during the next accounting period or at least within the next year. Ultimately, this decision was made because no cost was actually incurred and to keep things organized, releasing the accrual is the best action.

Although I agree with the manager’s decision, I believe that the accountants are ethically responsible to prevent inflation of profit. In this situation, it may have been best to get a third opinion before taking any action. Unfortunately, there were not many options in this situation; if there was not enough evidence for an audit and the billing was not received, the accruals could either sit there or be dropped. This decision was very difficult for my friend, who had little experience in the field; however, with guidance from her manager, I believe that she did make the best choice available to her.

References

Accual. n.d. In thefreedictionary.com. Retrieved September 15, 2013, from http://www.thefreedictionary.com/accrual

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