Description of what Accrual Accounting is and how accrual accounting is used in the TMS.
What is Accrual Accounting?
Accrual accounting is a financial accounting method that allows a company to record revenue before receiving payment for goods or services sold and record expenses as they are incurred.
In other words, the revenue earned and expenses incurred are entered into the company's journal regardless of when money exchanges hands. Accrual accounting is usually compared to cash basis of accounting, which records revenue when the goods and services are actually paid for.
KEY TAKEAWAYS:
- Accrual accounting is an accounting method where revenue or expenses are recorded when a transaction occurs vs. when payment is received or made.
- The method follows the matching principle, which says that revenues and expenses should be recognized in the same period.
- Accrual accounting uses the double-entry accounting method.
- Accrual accounting is required for companies with average revenues of $25 million or more over three years.
- Cash accounting is the other accounting method, which recognizes transactions only when payment is exchanged.
Accrual Accounting vs. Cash Accounting
Accrual accounting can be contrasted with cash accounting, which recognizes transactions only when there is an exchange of cash. Additionally, cash basis and accrual differ in the way and time transactions are entered.
Cash Basis of Accounting
Cash accounting uses transactions when payments are made. For example, consider a consulting company that provides a $5,000 service to a client on Oct. 30. The client received the bill for services rendered and made a cash payment on Nov. 25. Under the cash basis method, the consultant would record an owed amount of $5,000 by the client on Oct. 30, and enter $5,000 in revenue when it is paid on Nov. 25 and record it as paid.
Accrual Basis of Accounting
In contrast, accrual accounting uses a technique called double-entry accounting. When the consulting company provided the service, it would enter a debit of $5,000 in accounts receivable (debits increase an asset account). When the payment is made on Nov. 25, the consultant credits (credits decrease an asset account) the accounts receivable by $5,000 and credits the service revenues account, a revenue account (credits increase a revenue account ) with $5,000.
The received capital can then be moved to other accounts, such as free cash if needed—the company uses the same double-entry method to enter which account the capital came from and is moved to.
What Is the difference between Cash Accounting and Accrual Accounting?
Cash accounting records payments and receipts when they are received. Accrual records payments and receipts when services or goods are provided or debt is incurred.
Accrual accounting follows the matching principal, which states that revenues and expenses should be recorded in the same period.
Why use accruals?
The accrual method does provide a more accurate picture of the company's current condition, but its relative complexity makes it more expensive to implement.
Under accrual accounting, firms have immediate feedback on their expected cash inflows and outflows, making it easier for businesses to manage their current resources and plan for the future.
- Recognize Expenses and Income At the Same Time
- Over 25MM in gross revenue
- Financial Institutions and Investors will require it
- Compliance with GAAP
GAAP – Generally Accepted Accounting Principles
Generally accepted accounting principles (GAAP) refer to a common set of accounting rules, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the U.S. must follow GAAP when their accountants compile their financial statements.
GAAP is guided by ten key tenets and is a rules-based set of standards. It is often compared with the International Financial Reporting Standards (IFRS), which is considered more of a principles-based standard. IFRS is a more international standard, and there have been recent efforts to transition GAAP reporting to IFRS.
- GAAP is the set of accounting rules set forth by the FASB that U.S. companies must follow when putting together financial statements.
- GAAP aims to improve the clarity, consistency, and comparability of the communication of financial information.
- GAAP may be contrasted with pro forma accounting, which is a non-GAAP financial reporting method.
- The ultimate goal of GAAP is to ensure a company's financial statements are complete, consistent, and comparable.
When do we recognize revenue?
Revenue recognition is a key part of the Accrual Process. However, there is NOT a firm rule as to when revenue is recognized.
Quickbooks, and TMS, will automatically use both Cash and Accrual accounting. It is a setting in QuickBooks. The standard way to recognize revenue is when the invoice is created.
GAAP requires that we recognize revenue when the INVOICE IS CREATED.
- Pickup Date
- Delivery Date
- Invoice Date
- Transaction Date (Accounting Sync Date)
- Payment (Cash Accounting ONLY)
TMS keeps the dates separate so customers can recognize revenue when it is most applicable to them. For Example, Invoice Date is different from Pickup Date and the Accounting Sync Date (aka Transaction Date).
How do we generate accrual reports in TMS?
Reporting on accruals is needed if the customer decides to recognize revenue at pickup date or delivery date. If the customer recognizes revenue at the Bill Date / Invoice Date, additional reporting and journal entries are usually not needed. This can change if the customer chooses to accrue bills when the bill date and invoice date have significant gaps.
Reporting Tools in TMS
- Transaction Detail Report
- Unapproved Bills Summary
- Custom Reports
- Accounting Sync Reports
Once the report is generated, a Journal Entry should be added to the accounting system for the month. There should be a single journal entry for AR and, another for AP, possibly a third for commissions.
These reports should be saved by the customer and stored with their accounting team, so they have the ability to show the calculations when doing a financial audit. Reports should be granted monthly. When using the pickup or delivery date, it is a best practice to generate the reports a few days after the end of the month so operations can complete pending shipments.
Revisions to invoices and bills
Revisions to invoices and Bills can be a very complicated part of the accrual process. There are easy ways to make this work.- Recognized Today
- We can’t recognize revenue if we don’t know about it
If we follow those two rules, we will be able to simplify the recognition model for revisions. This will follow the primary rule of accrual accounting and recognize revenue when the invoice is created. This is why we create revision invoices as separate invoices in TMS.