Accruals accounting and why it matters

Most companies and management know that bookkeeping and accounting is essential to making correct financial decisions, however, not all know the importance of properly making accruals in preparing management reports for decision making.

Concept of Accruals

For companies that provides services or goods over a period of time or are engaged in projects. Most bookkeeping services will result in a distorted view of the business performance. That is because most bookkeeping services will only record sales and invoices based on the document date.

Let’s look at an example for a school where school fees are charged in advance and lessons are provided subsequently once a week. Hence, if the business charges $20,000 in Dec for lessons for the next quarter, the bookkeeper will generally record sales of $20,000 in Dec, while the cost of the teachers salary will be recorded in Jan to Mar of the next year. When management looks at the accounts prepared in such a way, management will see Dec as a very profitable month while Jan to Mar will be loss making months.

When we apply accruals accounting to the above example, the bookkeeper will allocate the $20,000 over the next three months Jan to Dec, hence each month will reflect sales of $6,666 per month.

That results in a more accurate view of the Company’s profitability over a period in time. Management use the information to make accurate decisions such as to increase school fees for certain dates or to reduce staff costs by reducing unprofitable classes.

When the management accounts prepared is inaccurate, it can also lead to other issues such as the company declaring interim dividends based on a profitable set of figures but only to realise that the company is not profitable after applying accruals accounting when preparing its financial statement.

Is Accruals Accounting a choice?

Under Companies Act, we can refer to the below paragraph:

201 (2) Subject to subsections (12) to (15), the financial statements referred to in subsection (1) shall comply with the requirements of the Accounting Standards and give a true and fair view of the financial position and performance of the company.

What is the Accounting Standards that is referred to under the paragraph? It is defined under the Act as:

“Accounting Standards” means the accounting standards made or formulated by the Accounting Standards Council under Part III of the Accounting Standards Act 2007 and applicable to companies and to foreign companies in respect of their operations in Singapore for the purposes of this Act;

For most of Singapore SMEs, the accounting standard referred to will be the SFRS for Small Entities which states that “An entity shall prepare its financial statements, except for cash flow information, using the accrual basis of accounting. On the accrual basis, items are recognized as assets, liabilities, equity, income or expenses when they satisfy the definitions and recognition criteria for those items.”

Hence, it is not a choice for management to decide if accruals accounting should applied or used but its mandated by the regulations. Even if it is not mandated, why will management or business owners not want a better measure of their company’s performance?

Over here at Pikai, we prepare management accounts on a accrual basis as we believe in empowering business owners and managers with accurate information for decision making. To find out more, Drop us a note.

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