Accrual Accounting Fundamentals

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1 Accrual Accounting Fundamentals A Primer To assist in maintaining the knowledge and skills after training.

2 Outline of program Introduction to Accrual Accounting Terminology - Definitions Key Financial Reports Accrual Accounting Versus Cash Accounting 2

3 Basic terminology Accrual accounting breaks all transactions down into the following groups: 1. Assets 2. Liabilities 3. Equity 4. Revenue 5. Expense 3

4 Asset An item of value controlled by an organisation (e.g. buildings, computers) An example of an asset: Accounts Receivable External parties from whom amounts are owed (to the organisation), for the supply of goods or services 4

5 Liability An amount owed by an organisation to an external party (e.g. loan) An example of a liability: Accounts Payable External parties to whom amounts are owed (by the reporting organisation), for the supply of goods and services 5

6 Current v non current assets Current assets Cash and other assets that would be consumed or converted into cash within twelve months Non-current assets Assets not expected to be converted into cash or completely consumed within twelve months 6

7 Current v non current liabilities Current liabilities Liabilities which would be due and payable within twelve months Non-current liabilities Liabilities which are not due and payable within twelve months 7

8 Equity The net worth of an organisation Assets Liabilities = Equity What of value we control less what we owe Is the equity!! 8

9 Revenue The inflow of resources into an organisation (e.g. appropriation - based on outputs) that results in an increase in assets or a decrease in liabilities Think of revenues as things we do that make us economically better off Remember though revenue is not cash!! Revenue is is doing the work not being paid for it Revenue often results in the creation of an asset called accounts receivable 9

10 Expense A cost or outflow of resources from an organisation (e.g. electricity, salaries) that results in a reduction in assets or an increase in liabilities cost or expense is not buying something of value it is consuming something of value Buying a Mars Bar is not an expense eating the Mars Bar is the expense!! 10

11 Prepayments The payment of an expense in advance. As we have paid for an expense we have not yet incurred we have a store of value. So a prepayment is considered to be an asset. 11

12 Accrued expenses An accrued expense is an expense which you know has occurred but has not been paid for or invoiced. An example might be electricity. At the end of the month we know we have incurred a cost for the use of electricity but may not have a bill. To ignore it would distort our costs in examining our performance for the month so we can accrue the cost by making an estimate of the cost of electricity (something we can probably do quite accurately) for the month. 12

13 Key financial reports There are three key financial statements: The Income Statement Balance Sheet Statement of Cash Flows 13

14 Statement of Cash Flows The report which shows the in flows and outflows of cash for a reporting period. In other words where did we get cash from (being paid for services provided) and what did we do with it (what did we pay for: buildings, labour etc) 14

15 Income Statement A financial report showing the revenue, expense and operating result ( the difference between revenue & expense for the period) of an organisation for a specified period 15

16 Balance Sheet A statement of assets, liabilities and equity for an organisation at a particular point in time A statement of what we have (control) what we owe and what's left over 16

17 The three key accrual reports Statement of Cash Flows for July Receipts Cash rec d from Gov t Cash rec d from others Payments Cash paid for rent Cash paid for labour Cash paid for goods etc. Cash paid for equipment Cash increase in Jul Cash at start of Jul Cash at end of Jul 150, ,000 30,000 80,000 20,000 18, ,000 2,000 50,000 52,000 Balance Sheet end of June and July Assets Cash Equipment Receivables Liabilities Payables Owed to labour Net assets Equity Jun 50, , ,000 50,000 Jul 52,000 17,500 5,000 74,500 40,000 2,000 42,000 32,500 32,500 Income Statement Revenues Earned from Gov t Earned from other clients Expenses Rent cost Labour cost Goods and service cost Equipment cost (ie. dep n) Operating result for July Net assets at start of Jul Net assets at end of Jul 150,000 5, ,000 30,000 82,000 60, ,500 (17,500) 50,000 32,500 17

18 Accrual vs cash accounting Cash accounting Only records transactions when the cash moves in or out Accrual accounting Records transactions when they happen i.e. Revenue when it is earned and expenses when they are incurred, not when the cash is received or paid 18

19 Accrual accounting Cash Outflows on non-current asset acquisitions are recorded as assets, NOT expenses Cash Inflows from loans are recorded as liabilities, NOT revenue Takes account of non-cash expenses such as Depreciation and Long Service Leave 19

20 Expense recognition Non-cash expenses Depreciation (the using up of the value of the asset over its estimated useful life) Long Service Leave 20

21 Expense recognition For reporting purposes, expenses should be recognised in the period in which they are incurred, not when they are paid. 21

22 Expense recognition Accrual Accounting recognises the expense here Send Purchase Order to Supplier Receive goods Pay supplier Cash Accounting recognises the expense here 1 August 30 June 20 June 25 May 22

23 Revenue recognition Revenue recognition principle Revenues should be recognised in the period in which they are earned, not when they are received 23

24 Summary of accrual & cash Revenue Expenses Assets & Liabilities Accrual When goods and services are provided. When goods and services are consumed. Reports all assets and liabilities. Cash When cash is received. When cash is paid. Reports on cash. 24

25 THE END Thank you