Accruals and AA.

What are accruals? I get asked this a alot these days and I'm amazed that I find it difficult to answer. But basicaly - its what accountants get paid for! :)

Formal definition: Accruals = Profit - Cashflow.

If you need a definition of profit - its covered in a previous post, go do some research. If you don't understand mathematics, accruals are what makes up the difference between profit and cashflow. The basic purpose of accruals is to ensure that the profit recorded for a given accounting period, actually relates to that period.

For example:

A construction company, Constructions R Us received a payment in advance of $1 Million on the 1st January 2006 for a building which is expected to take 1 year to complete. Construction commences on the 1st of January. At the 30th June 2006 half of the building is complete. $250,000 worth of material and labour has been used and paid for. $50,000 worth of concrete has been paid for and will be delivered next week. Assuming this is the only work done by Constructions R Us for the financial year ending 30th june 2006, how much Cash and Profit is earned?

Cash flow:
A.) Cash Receipts = $1,000,000
B.) Cash expenses = $250,000 + $50,000 = $(300,000)
C.) Cash Flow = $700,000 (A - B)

Profit:
A) Revenue = 1,000,000 / 2 = $500,000
B) Expenses = $250,000
C) Profit = $250,000 (A-B)

Accruals:
A.) Accrued Revenue = $500,000
B.) Deposits paid = $50,000
C.) Total accruals: $(450,000) (B-C)

Accrued Revenue is a liability - Constructions R Us owes the customer for work not yet done.
Deposit paid is an Asset - concrete company owes constructions R us $50,000 worth of concrete.