Which figure goes to P&L? Accruals and closing off an expense account

soroem1soroem1 Posts: 12Registered
Hi,

Been a while since I passed my Level 3 and have recently been trying to get my head around accruals and prepayments again. Having a bit of trouble remembering the order things must be carried out in when closing off accounts and sending values to the P&L.

For example:

If I have an Electricity expense account at year end that looks (initially) like this:



DR .........................................................CR
..................................................b/d Accrual brought down 100
Bank 1000 .................................c/d 900

-------------------------------------------------------
1000......................................................1000
--------- ---------------------------------------------

b/d 900

When closing off that account, that £900 c/d figure goes to the P&L doesn't it - which highlights a £900 debit balance for the Electricity expense? So the carrying figure on any P&L account at your period end becomes the value displayed on the Statement of Profit or Loss?

Right,


What happens if you then need to adjust the account for a further accrual:


DR .............................................................CR
.....................................................b/d Accrual brought down 100
Bank 1000
Accrual (one month) 100.............c/d 1000
---------------------------------------------------------
1100 1100


b/d 1000


I don't think the above is correct. From the literature, I have read that the accrual would be the carrying figure? But how does that work, as surely you need to net the account off INCLUDING the accrued expense for the period to get an accurate P&L balance?

Think I've tied myself in knots.

If I put that one month accrual in it means I have used the months electricity, though haven't paid for it yet. So the accrual goes in the expense account as a DR and in the balance sheet as a CR (liability). At the start of the next period, this is reversed so, the accrual is a CR entry in the electricity account, and when I do pay that invoice the month expense is netted off immediately to zero - it has been accounted for in the previous period.

But doesn't that mean the Accrual should be the balancing c/d figure?

If it should be, with the figures I have there, how do you close off the account for the P&L correctly?

Very confused.

Thanks

Answers

  • stevefstevef Well-Known CarmarthenPosts: 258Registered
    The P&L a/c is part of the double entry so the transfer has to be posted to the expense account, so in your second case becomes
    Dr___________________________________________________CR
    ___________________________accrual balance bd 100
    ________Bank 1,000
    _________________________________________to P&L 1,000
    accrual balance cd 100

    -------------------------------------------------
    __________________1,100_________________________1,100
    -------------------------------------------------
    ______________________________________balance bd 100
  • soroem1soroem1 Posts: 12Registered
    Thanks for the reply Stevef,

    Still a little unclear.

    So - in the first case (without accrual), we would have £900 that is the carrying figure and also the figure sent to the P&L (by debiting it out of the account and crediting it into the P&L Expense account?)

    However, in the case where an accrual adjustment is required - is the accrual always classed as the carrying figure, and the balancing figure on the other side of the T account, INCLUDING the accrual, sent to P&L?

    So, in this scenario:

    DR___________________________________CR
    ___________________________________accrual balance bd 100
    Bank 1000
    Accrual 100
    ----------------------------------------------------
    1100________________________________1100
    ----------------------------------------------------

    1) I would sum the highest side of the T account - in this case the DR side - £1100 Bank payment and the £100 accrual.

    2) That accrual needs to be brought down to the next period, so I would have to class that as the carrying figure (?)

    3) To balance the account off and send to P&L, I would see that the CR side needs £1000 to balance, so that is the figure sent to P&L. As it is part of double entry, to do this step by step, you would DR the Expense account the £1000, then CR the P&L Expense account £1000? (I know you would likely just write "To P&L" in the account, but thats what is effectively happening right?)



  • stevefstevef Well-Known CarmarthenPosts: 258Registered
    Hi,

    In the first scenario
    You have an opening credit balance of £100 (the accrual)
    a debit transaction of £1,000

    As this is an expense account with no accruals or prepayments to carry forward, you will have to even the two sides of the account up, to do that you will

    Debit P&L £900 and credit the expense account £900

    This will leave both sides of the expense account totaling £1,000, no expense account brought down and an expense item of £900 in the P&L



    In the second scenario
    You have an opening credit balance of £100 (the accrual)
    a debit transaction of £1,000
    but you need to accrue another £100, so debit the expense account

    As this is an expense account the amounts accrued or prepaid in the accounting period need to be carried down, all other balances need to be cleared to the P&L
    so
    Debit P&L £1,000 and credit expense account £1,000 and
    Debit expense account in current period £100 and credit expense account with £100 in the next period

    In the current period both sides of expense account will equal £1,100 and a £1,000 expense in the P&L
    In the next period you have a credit b/d of £100, the accrual or carrying amount, memo'd to the balance sheet.
  • soroem1soroem1 Posts: 12Registered
    Ah thanks again for feedback stevef.

    This is again where the double entry mechanism of carrying figures down to P&L eludes me.

    In a scenario without accrual - is it that:

    When entering a carrying figure on the CR side of the expense account, that is one side of the double entry. The other side is the DR in the next period (brought down figure)? When finalising the accounts for the period, this carrying figure is the one that is posted to P&L (it is also brought down in the next period).

    However, when the accrual is involved, I thought that when entering the £100 accrual on the DR side of the expense account, the other side of the double entry would be to CR the balance sheet accrual liability.

    Then, upon the next period, reversing the accrual by DR'ing the accrual liability account would then necessitate a CR in the expense account?

    This doesnt appear possible if the accrual is brought down on the CR side? DR accrual liability and CR expense accrual would = no movement.

    So how is it that the Accrual is carried down in the expense account when there is already a carrying figure that is brought down in the next accounting period (i.e. the £1000 balance)?

    Manually bringing the accrual down on the opposite side of the account seems to break the double entry convention to me, especially if there is an accrual liability sitting in the balance sheet already on the CR side.
  • stevefstevef Well-Known CarmarthenPosts: 258Registered
    Hi, I have assumed in my previous posts that as you mentioned the P&L a/c we are talking about year end procedures not month to month, if this is wrong please let me know.

    At year end, the basic rules to the accounts closure game:

    all ordinary revenue expense or income accounts need to be cleared, unless there are accruals or prepayments, these have to be carried forward to the new year.

    asset and liability accounts will have balances carried forward.

    The P&L account (or whatever it is called these days) is part of the double entry system, it is the eventual home for the other side of the transaction to clear the revenue account. This may not be a direct entry and some other intermediary accounts may be used to classify and accumulate, but it is the P&L a/c final destination.

    The Balance Sheet is not part of the double entry system, it is a list of balances remaining in the double entry accounts arranged in a meaningful way.

    So , with no new accrual, before making the closing entries you have a £900 debit, this is an expense account so has to be cleared the journal entry to clear it is
    Debit P&L (or the intermediate mechanism) £900
    Credit the expense account £900
    The expense account is clear, there is no carrying value, there is £900 debit in P&L.

    With the new accrual, before the year end postings you have a £900 debit, but you know that there is a £100 accrual so the P&L account needs to be debited with £1,000, to do that the journal entry is
    Debit P&L (or the intermediate mechanism) £1,000
    Credit the expense account £1,000

    this leaves the expense account out of balance, the debit side is £100 light, to bring it into balance you
    put a debit of £100 in the current year, balance carried down,
    to complete the double entry, credit next year with £100 balance brought down.
    It is the brought down £100 that is your carrying amount. The carrying amount is included in the list of balances which forms the balance sheet and classified into the correct heading.


    The above is the year end game, if we are in mid year and doing a bit of week/month/quarter tidying, there is no P&L account posting.

    With no new accrual,

    Add up both sides you get a Debit total of £1,000 and a credit of total of £100, so in current month credit expense account with £900 balance carried down, and debit new month £900 brought.

    With new accrual (its clearer not to net accrual off but you could if you wanted)

    You already have an opening credit accrual of £100 and a debit posting of £1,000. To deal with the new accrual

    Debit current month with £100 accrual for year, credit next month with £100 accrual carried down.

    Now add up both sides to get a debit total of £1,100 and a credit of £100. To clear, credit current month £1,000 balance carried down, debit next month with £1,000 balance brought down.

    The current month is now balanced at £1,100 and next month has two opening balances, a debit of £1,000 and a credit of £100.
  • soroem1soroem1 Posts: 12Registered
    Thanks again stevef for taking the time to explain everything long-hand. It is very much appreciated.

    That is very helpful and has cleared a few things up for me regarding the carry down mechanism on the expense accounts -

    1) The double entry is the Debiting (£100 in this case) to the expense account AND the simultaneous Crediting to the next period, brought down.

    2) This bringing down mechanism does not interfere with the posting of the account balance to P&L. Instead, the figure posted to the P&L is the balance on the [credit] side (£1000 here) that takes account of the total expense for the period. The original CR accrual (£100) that was present in the account at the start of the period actually relates to a previous period, so does not need to be reflected in the figure that is posted to P&L for this period? Is that correct? (If so, then that is one of the key lightbulb moments for me understanding this!)

    Separately, what I meant previously when I referred to the 'balance sheet' was the Accrual Liability account that would appear on the balance sheet under current liabilities. Is this not part of the double entry system?

    Re-reading my books, it seems the process for entering an accrual in the accounts requires an Credit entry in the Accruals liability account - represented in the statement of financial position. According to the Level 3 book, this happens in Step 2 of the accrual process - when bringing the CR down in the expense account, "the credit balance... will be listed int eh statement of financial position as an accrual". Unfortunately it doesn't say how it gets there.

    How does the accrual you are handling in the expense accounts relate to the liability account? Or is it a matter of timing? If you received a bill relating to a previous period, though had done nothing about logging it in the accounts as an expected liability, there would be no reason to create the accrual liability would there? When you get your bill you would post it within the expense accounts and probably pay it quickly...

    Im still quite unclear on this relationship between expense accounts and the associated liability-side of accounting for the accrual.
  • stevefstevef Well-Known CarmarthenPosts: 258Registered
    Yes . 1) and 2) seems right.

    The balance sheet or statement of financial position is not part of the double entry system, as your text book says, it lists things.

    In my replies I have been describing a direct posting of balance c/d in one year to balance b/d in the next year. But I did mention that sometimes an intermediary account is used to make the collection and classification of balances easier. The accruals liability account is an example of such an intermediary account and is a mechanism I use in my organisation to make life easier during closure. The Accruals liability account is part of the double entry system.

    The way it is used is as follows:
    You have established that you need to carry down £100 in the expense account because of that pesky accrual, so:

    1) In the current year
    Debit expense a/c £100, credit accrual liability a/c £100

    This clears the expense account.

    2) Clear the accrual liability account by
    Debit accrual liability account £100 in current year
    Credit accrual liability account £100 in the new year

    This gives a balance to be listed in the balance sheet

    3) In the new year
    Debit accrual liability a/c £100, Credit expense a/c £100

    Which puts you in the same position if you had not used the intermediary account.

    So why go to all that trouble you are asking, well with one or two accruals you would not go to those ends, but if you have hundreds then the accruals liability account gathers them all together to give you the one figure you need for the balance sheet.

    Where I work, we have programmed the ledger to automatically carry out the new year postings if we flag the current year journal as an accrual. As I have said, the accruals liability account is not necessary, but makes life so much easier if you have a number of accruals (particularly if you part automate the process). The accruals liability a/c is part of the double entry system with the balance on it being "listed" in the balance sheet.
  • soroem1soroem1 Posts: 12Registered
    As always, thanks for your patient explanations Stevef.

    That is a lot clearer now - much easier to see what happens and why when the full process is laid out.

    Cheers
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