One of the most important and useful principles in accounting is the principle of accruals. Before we get into the details of how the accrual is important in accounting for industry, let us first understand what an accrual is. In simple terms, it means recording the revenues and expenses in the proper period in which they occur so the revenues and expenses are matched up together. So this means a cost is recorded in the period in which it is committed and not the month in which it is paid for. In the same way, if the revenues are “earned” this month, it will be recorded this month even if the funds are received afterwards.
Capital Expenditures and Accruals
Capital expenditure are different when compared to normal operating expenditures because often times they occur over multiple accounting periods. The payments of such large amounts do not reflect when the “commitments” are made and therefore do not accurately reflect the financial position of the company. Due to this factor, a business must accrue the expenditure over multiple accounting periods rather than the one it is paid.
Monthly Accruals, Quarterly Accruals, Capital Accruals
In industry, accruals happen monthly, quarterly and annually. If a good or service is sold in March and the money is received in May, it will be recorded in March. If a Purchase Order for equipment is cut in April and the invoice is received in May, the capital is accrued for in April because that is when the commitment is made.
It is not unusual for a manager to have 50 simultaneous projects of all types, sizes, at various stages, and with different service groups involved. It is very challenging to keep on top of committed capital by itself much less worrying about the timing of such committed capital.
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