USA What date do you use when entering an expense into a ledger with accrual accounting?

[dentedduck]

Hi,
I'm on a condo board and in going over our financial statements I've noticed that for many categories it's very common to see a category have no expenses listed for a couple of months, but to have the Year-To-Date column for that category increase. After asking a bunch of questions of the bookkeeper I think I've finally pinpointed where the discrepancy comes from.

We are using accrual accounting and it seems that when a bill comes in, they are using the invoice date to determine which month the expense should get logged. This very often leads to a situation where a contractor generates an invoice at the end of the month but it doesn't reach us until the beginning of the next month.

As an example, we just had some electrical work done. The work was done in June, but the invoice was dated on 7/9. We didn't receive the statement until about 8/14. At that point, the board has already received the statement for June and July and the expense wasn't recorded in either. Then when the board got the August statement, the expense was only recorded in the Year-to-date column, since the expense was back dated to July (the invoice date). It seems that using the invoice date very often leads to the board not knowing when or where the money was spent since all of our statements have the Current Period column showing $0 spent. I've added up the discrepancy between the sum of all of the current periods and the Year-to-date columns and it's about $22k or 4-5% of our budget. It seems like a lot to me.

The question I have is, is this normal? Shouldn't the date of receipt of the invoice be used to categorize the bill? After all isn't that the date we become liable for the bill?

Thanks in advance for your help!

Dave

 

[ArcSine]

With accrual accounting, invoices should be considered as expenses of the month in which the work was performed by the vendor for your organization. So more accurately, that electrical work was an expense of the month of June, not of July 09 (invoice date), nor of August (when invoice received).

But that is indeed the reason for the phenomena you're seeing on the reports: YTD expense increases in some particular month (vs. the prior month's YTD), while the "month" column shows -0- for that particular month.

But the answer is not to bail on accrual accounting, as (compared to the alternative, cash-basis accounting), accrual gives you a more accurate read on the true economic performance and activity of your organization.

Instead, there are workarounds for this problem that come in different flavors; the choice depends on the particular set of facts and circumstances at hand. For example, I've seen different variations on this general idea: At each monthly meeting, you review the financial statements for the immediately preceding month, which you're seeing for the first time. You'll also review any financial statements of previous months (which had been initially reviewed in previous meetings) which have been amended by the introduction of late-arriving invoices.

Thus, for example, when you're meeting over the August financials, the accountant also furnishes you with revised June reports, in which the "June month" column now includes the electrical work as an expense, but which was omitted from the "first pass" June statements that you saw a couple of months ago, due to the invoice-arrival timing issue.

In some cases, where feasible, these "revised prior reports" incidences might be mitigated somewhat by the accountant's use of "PO" entries. For example, when the electrical work was completed in June, the bookkeeper has in hand a completed work order giving the nature of the work, the day(s) such work was performed, and the agreed-upon price. On this basis, the bookkeeper records the expense onto the June books, knowing that an invoice is forthcoming.

Of course, this latter method requires a rigorous, reliable purchase-order system to be in place.

Other organizations find that delaying their monthly meetings by a few days allows for a few more late-arriving invoices to be introduced into the books in the proper month to begin with (and hence fewer after-the-fact amendments to earlier statements). Again depending on the circumstances, that might be an acceptable tradeoff.

 

[dentedduck]

Hi ArcSine

Thanks so much for your reply. I'm glad that you can confirm that our bookkeeper is doing things right, even though I'm a bit dismayed by the difficulty we'll have in keeping track of our expenses. I guess that the best route is to make sure that we get the revised statements.

Given these difficulties, some on the board are advocating for switching to cash accounting for the next year. I know you mentioned that accrual gives us a better read on our true economic performance, and I've seen this repeated in may places on the internet, but I don't have a good sense for how so. Could you give an example of how accrual is better?

Best,

Dave

 

[ArcSine]

Accrual acctg trumps cash acctg in the sense that revenues are mapped to the reporting period (month, quarter, year) in which the revenue was earned rather than received; expenses are mapped to the period in which the expense was incurred rather than paid.

For example, when your electrical work was completed in June, at that point you had incurred the expense. You had a legal obligation to pay the electrician as soon as his job was satisfactorily completed. Hence, any June 30 balance sheet which did not reflect this obligation would be understating your organization's total debts and liabilities as of June 30, and the June P&L would be understating the expenses your org had incurred to such date.

Having said that, though, cash-basis accounting co-exists with accrual, and has its own fan base; it's a cost-benefit thing. In some cases, the superior informational value of accrual acctg over cash basis is so slight as to render the additional effort a poor investment. It depends on the idiosyncrasies of the situation. Cash-acctg might have a good argument in your case if (for example) one or more of these conditions are present and have sufficient weight...

• The total expenses your organization incurs month-to-month isn't of such magnitude that an accurate matching of months and expenses is critical;
• The majority of your expenses are of a steady, recurring nature (such as a fairly flat monthly fee for maintenance, landscaping, etc.)---for such expenses there isn't much month-to-month diff between accrual and cash accounting;
• The board members have enough hands-on knowledge of the day-to-day operations that a little imprecision in the month-to-month financials is no big deal;
• What really matters isn't so much accuracy month to month, but rather that the end-of-year reports, covering the entire 12-mo period, must be accurate.

A cash / accrual compromise that many firms find attractive is to keep the books on cash throughout the year (with an understanding that, e.g., an expense might show up on the August P&L when in reality it was a June expense), and then after the end of a fiscal year the accountant takes the additional steps to convert the books to accrual basis. Then the tax returns, and the more-important annual reports, have the accuracy advantage of accrual accounting, while the interim-year monthly reports have the simplicity advantage of cash basis.

(Side note: If your org has any outside-reporting obligations (e.g., having to provide quarterly financials to a bank while a loan to your org is outstanding), review the associated docs and agreements carefully to see if the outside party has placed some reporting mandate in the deal, such as requiring the financials to be prepared on the accrual basis. If not, you're generally free to set up your bookkeeping in whatever manner best suits your situation.)

 

[dentedduck]

Wow, thanks so much for all of your help!

 

[ArcSine]

Happy to help, amigo....best of luck with the board.