How to record accruals

Bills and invoices don't always line up with the period the work or the usage belongs to. Electricity used in June may be billed in July. A job finished on the last day of the month may be invoiced the following week. Left alone, June's figures would miss the cost and the income, and July's would carry them instead.

An accrual is a journal entry that puts the amount into the right period before the document arrives. business.gov.au explains that accrual accounting records expenses and sales when they take place, and that it shows the amounts a business owes and is owed. Accruals are how that happens for items not yet billed.

Accruals are usually made at the end of a period you report on, such as a month end or 30 June, when the Australian financial year ends. Common examples:

• utilities used during the period but billed after it
• interest on a loan for the period, charged by the lender after it ends
• work done for the business by a contractor who hasn't billed yet
• work the business has done for a customer but hasn't invoiced yet.

business.gov.au's balance sheet template shows where accrued costs end up: it lists interest payable and accrued wages among current liabilities. Whether a small amount is worth accruing is a judgement your accountant can help with.

• Accrued expense: debit the expense account, such as electricity or interest, and credit an accrued expenses account, which is a liability.
• Accrued income: debit an accrued income account, which is an asset, and credit the income account. Whether and when income can be recorded before it is invoiced is a question for your accountant.

Date the accrual on the last day of the period and describe it fully: what it is for, the period it covers and where the figure came from.

June now carries the estimated electricity and the income it earned. In July the reversals cancel against the real bill and invoice, so July's electricity shows only the gap between the estimate and the actual bill, and July's sales show nothing for work done in June.

There are two common ways to unwind an accrual, and either works if you use it consistently.

• Reverse on the first day of the next period, as in the example, then enter the bill or invoice as normal when it comes.
• Leave the accrual in place and, when the bill arrives, record it against the accrued expenses account rather than the expense, with any difference going to the expense.

The risk with either is forgetting. An accrual that is never unwound counts the cost twice once the real bill is entered.

An accrual is often an estimate, but it shouldn't be a guess. Good sources include:

• a meter reading, or the same period's bill from last year
• a contract, quote or purchase order setting out the price
• the lender's repayment schedule for interest
• a contractor's timesheet or a note of the work completed.

business.gov.au's profit and loss and balance sheet templates ask you to label estimated figures clearly. Keep the working behind each accrual. Companies have a specific rule: the Corporations Act's definition of financial records takes in the papers needed to explain adjustments made when financial statements are prepared, and a company must hold its financial records for 7 years once the transactions are complete.

Sometimes the business pays before the period the cost belongs to, such as insurance paid for the year ahead. That is a prepayment, the reverse of an accrued expense. business.gov.au's balance sheet template lists prepaid expenses among current assets. How and when a prepayment moves into expenses in your accounts is a question for your accountant.

Keep a list of the accruals made at each period end and check each against the bill or invoice when it arrives. An amount from an earlier period can remain valid while it is still unbilled. If you reverse accruals at the start of a period, include any amount still outstanding when you prepare the next period-end accruals. Investigate old balances rather than clearing them just because they are old.