Presidents Message: July 2017
Definition: Accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged. The term “accrual” refers to any individual entry recording revenue or expense in the absence of a cash transaction
Most businesses typically use one of two basic accounting methods in their bookkeeping systems: cash basis or accrual basis.
The cash method is the most simple in that the books are kept based on the actual flow of cash in and out of the business. Income is recorded when it’s received, and expenses are reported when they’re actually paid.
With the accrual method, income and expenses are recorded as they occur, regardless of whether or not cash has actually changed hands. The accrual method is required if your business’s annual sales exceed $5 million and is structured as a corporation. In addition, businesses with inventory must also use the accrual method.
Companies using the accrual method will have accrual accounts where they record or make an adjustment for an expense that has been incurred but not yet recorded. It appears on the balance sheet as a liability which is an obligation of the company. Think of this as a claim against a company’s assets or as an amount owed to a supplier for materials/inventory.
Having an accurate valuation of inventory is important because the reported amount of inventory will affect the balance sheet. The balance sheet is one of the major financial statements used to present a company’s financial position. If a Company had $1,000,000 in assets but owed $500,000, the net worth would be $500,000. If within that $500,000 there were $100,000 in errors (product received in error that we will not be billed to the Company), then the Company would have $1,000,000 in assets but owe $400,000, the net worth would be $600,000.
As Supply Chain professionals, it is important to work with finance to ensure we are receiving products/materials correctly and being invoiced for what we received to clear false accruals. An invoice for product we did not receive will sit as ‘open’ creating a negative accrual – showing an amount we owe, however we never received the product.
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