As you know, an expense arises when the obligation to transfer economic benefits arises, not when the expenditure actually incurred. That’s called accrual based accounting and as such it’s important to understand all conditions of certain agreements and transactions. It’s crucial to see those moments the obligation actually arises.  Continue reading →

Every now and then there are situations which may but may also not result in expenses for the company. It’s called uncertainty and something to measure it is called probability.

In a situation where it’s unsure whether you have to pay anything or not, it’s really difficult to recognize the balance in the accounts as such. In a situation where it’s probable the amount is due, you recognize a provision in the accounts. However, if you believe it’s more unlikely than likely (i.e. the probability is less than 50%), you do not recognize the amount in the accounts. So, as you might have guessed, your first course of action is do assess the probability – it’s all an estimation so there really isn’t a right or wrong answer. What the management estimates, is their decision. Just make sure it’s based on reasonable assumptions and accurate information.
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In a situation where your company is facing some potential financial difficulties or is going to face a possible liability that’s so big if paying it, it would mean bankruptcy, there’s an option to receive a promise from the owners or similar to get full financial support if a situation arises. Essentially what’s done, is an agreement between two parties where one side promises to support and the other is agreeing and acknowledging the receipt of such support.

Depending on the reason the support was given – either as something to assure your creditors or some particular financial institution, the first thing you should do, is make sure that the appropriate party is informed of such a support. It’s needless to say I presume that you won’t go about and advertise it publicly, but if asked and if questioned, you’d say that to the other party. It could be that financial institutions or auditors who have suggest for such a support letter, may ask for a copy.
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You’re accruing for missing invoices and possibly even revenue for which you haven’t issued an invoice yet into your balance sheet. There is a certain amount as a liability or an asset (in case of revenue accrual) on your balance sheet and everything couldn’t be more accurate. All your expenses and income are recognized in proper periods and as such the accounting is correct.

Now what to do when the invoices actually arrive or you are able to send an invoice to your client?
Something that you should not do is recognizing those invoices as expense or income. Why? You should not do it simply because they already went through your income statement in the prior period. Doing it once more just generates extra expense or income and messes up your accounting. I’ll tell you why.

Let’s say you have accrued for a supplier invoice so that you add expense to your income statement and also take up a liability. The entries are as follows:
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Accruals are something you create and recognize on the balance sheet for expenses and income when you haven’t gotten or haven’t issued the invoice yet, but you do know that it’s probable the transaction will happen and it does relate to the period at hand already.

Whereas you do not have the document for it, it’s imperative to have expenses and income recorded in proper periods. For such cases, there are “accruals”. Since the accounting is mostly done accrual based (i.e. when the event happens and not when the cash actually moves), there is no other way of getting things right, than accruing for income and expenses.
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