It’s such accrual world we live in
OK, accounting pun there in the title – sorry about that! But in this post we are going to review what is known as the accrual concept (which for students of accounting can be a very cruel thing to understand – ba-dum Tsss!
The accrual concept essentially states that all transactions (remember transactions?) are recognised in the period in which they are incurred.
Wow! That’s a mouthful!
Ok, let’s break it down – essentially what this means is that, for example, let’s say that you get charged $100 in April for rent – however you only pay this amount in May. So according to the accrual concept – you will only recognise this expense (remember expenses?) in the month of April and not May.
Still confused?
Ok, let’s try again – What this basically means is that the $100 expense is an April expense not a May expense (even though you made the payment in May). In a nutshell – transactions are only recorded based on the date you receive the invoice/bill for them NOT when you pay money for them.
Ok, so at this point you might be thinking – well, Sam does it really matter anyway? I mean, I’m still going to pay the money anyway, who cares if I pay it today or tomorrow or 6 months later?
Well, I’m going to tell you that it does matter! Because: tax reasons!! In order to accurately record transactions in the correct tax period – the actual date of the transaction is the date the invoice/bill is received by the business. This is important if you are a business owner/sole trader and you are paying taxes. Remember, there are only two things certain in life: Death and Taxes!
Again – another example, let’s say your financial year ends on 31 March 2019 (again, another Kiwi reference) and you have an invoice for a sale of $100 on 29 March 2019. You don’t get paid for this until 4 April 2019. This means that at the end of 31 March 2019, you will record the $100 worth of sale as income (remember income?) in the 2019 financial year and not in the 2020 financial year (even though that’s when you got paid).
So there you go, accounting is accrual world. Very, very much so. Most accounting regulations around the world operate based on the accrual principle – so its always a good idea to understand what that means.
WARNING NZ-SPECIFIC CONTENT AHEAD
Are you living and paying GST in NZ? If you are, then the accrual concept applies to you if you are paying GST on an invoice basis – this means you pay GST on sales and expenses based on the date you issue the invoices/receive the bill. If you are on a payment basis, then GST is paid based on the date you receive or make the payment (the actual transfer of cash). It might seem like a small thing, but its very important from a tax perspective.