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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Every now and then it may happen that you have to credit your sales – either returned goods, improper amounts on the invoice etc. There may be numerous reasons, but fact of the matter is, that sometimes you do have to do it.
Now whilst in essence it’s not that difficult, you just recognize an invoice with a negative figure and add it to proper client account, something you do have to be watchful with however is the period which revenue you’re decreasing. In the middle of the period it’s not a question, but if it’s prior period sales (and especially if it happens in January that you have to credit December sales), the credit should also be put into the period the sale it relates to was made.
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Let’s say that you ship off goods to your client on December 15 and since they are delivered by the ship, the expected date of receive for the client is January 14. It’s a long shipment and as such, one should always keep in mind the shipment terms.
If according to the terms the risks and rewards (i.e. ownership) is transferred in a way that the client has to take care of the transport, the customs etc. the goods belong to the client as soon as they are put on the means of transport. Depending on the terms of delivery the ownership is transferred at the time the client is responsible for them.
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When you’re dealing with long term shipments which take about more than 2-3 days, it’s always the question of when the risks and rewards have been delivered from the supplier to you as the buyer. The reason it’s important is the pure fact of when you should recognize the goods as in transit and on your balance sheet.
If you’re not dealing with long term shipments as often, the easiest thing to do is just right when you make the order and if applicable, also sign the agreement, just make sure that at that time you already know the terms of shipment and delivery. If you’re obliged to take care of the shipment itself, pay for it and say even insure the goods, its definite the risks have already transferred, so they are your goods.
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You have inventory for your business on your balance sheet and every now and then you need to purchase extra to keep the business going obviously. As it happens, the goods are never recognized in bulks, but in single units with their own unit price. Why? Because when you sell them, you mostly sell single units. Keeping that in mind, you have a unit selling price, so you must have the cost price for this single unit as well.
Regardless of this, you need to make sure the unit price is always right. It’s not just getting the right amount from the invoice, but also making sure you’ve added all the extra costs, like duties, transport fees etc. to the unit price. Normally those expenses are just spread across units the expense was made for (i.e. transport invoice is for a larger shipment, which includes like 1,000 units – the invoice amount is divided with the units and the result is added to a single unit price), or in case of bigger differences in unit own prices, you just take the proportion and then spread across units (i.e. 50% of the shipment was just 1 unit whereas the other 50% is like 500 units – the cost needs to be proportioned).
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As we already mentioned in our previous post, on occasions when some of your expenses are being compensated, there’s one key question you must ask. Do you know it for certain? The most important element when it comes to recognizing anything on your financial statements is the level of certainty – is it below or above 50%. As it is hard to determine, it’s something the management has to estimate.
So in a situation where the management has estimated that it’s definite the compensation is received, it needs to be recognized on the financial statements. The expenses themselves are recognized as always – debit the expense account and credit the liabilities. When the payment is done later on, you debit the liabilities and credit cash. Sounds easy enough, right?
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There are numerous businesses, where some of their expenses are being compensated by another party (i.e. party they are made for or who gets something out of it). Simply put you make an expense and this very same expense is later on either in full or partly being paid up by this someone else. You are the one paying for the supplier and you will receive compensation for it. Now the question is however, how do you recognize it all in your accounting?
Your expense is obviously an expense and should be recognized the same – under the income statement group it has always belonged under to. Hence also the liabilities and eventual cash payment is still done the same.
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As the main resource you generate with your business, is money, you want to make sure everything is in order when it comes to having an overview and managing your money. There are a couple of real life best practices I for one have in use for my own personal finances and have seen being used in other businesses as well.
First things first – create at least two separate accounts. One should remain the account you pay your invoices from and the other one is to be used by your customers (basically the account your cash inflows go to). At the end of the month (or week, which ever suits the best) you just transfer all those inflows to your other account you make payments from. This way you have a clear overview and simple structure as to from which account the payments have been done and where the money comes to.
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Ever since you’re taking yourself an accountant or you’re outsourcing accountancy alongside with bank payments, you have to ensure that the cash outflow is authorized. All payments done should be authorized obviously by none other than you, the manager or owner of the company.
Generally speaking, already in medium sized companies, if there’s an accountant (or team of accountants for that matter) there should always be someone else at least reviewing the payments. There are two main reasons for it – to prevent any mistakes and prevent any false payments.
We are all humans and as such, we tend to make mistakes – either with numbers, receiving party etc. The more there are payments, the easier those mistakes are bound to happen. We all do them and there’s nothing wrong in doing them. I have heard from countless accountants that they either really want someone authorizing the payments or if already implemented, they hugely appreciate it.
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