This article explains what accruals are and how to record them in FreeAgent if you're preparing your accounts using the accrual accounting basis. It also explains how to reverse an accrual.
Please note that the steps below don't apply if you're preparing your accounts using the cash accounting basis.
What is an accrual?
If you choose to prepare your accounts using the traditional accruals accounting basis, you need to record costs that your business incurs on your profit and loss account at the time when the business uses what it's paid for, which may not be when the cost was paid for. For example, you might pay a £300 electricity bill for your business's office on 1st May 2021, which covers electricity that the business used over a three-month period between 1st February and 30th April 2021.
So if your business prepares accounts to 31st March each year and you only include your electricity bill in your accounts when you pay it on 1st May, the £200 worth of monthly costs for February and March will be missing from your accounts to 31st March 2021. This would mean that your profit would be too high and you might pay too much tax, as part of your electricity payment relates to February and March 2021.
Therefore, you need to record the £200 of electricity costs for February and March on your profit and loss account as at 31st March 2021 by recording those costs as an accrual.
As the £200 will then be paid for in the accounting year to 31st March 2022, you'll need to remove it from your profit and loss account for that year by reversing the accrual.
Please note that when working out the value of the accrual, you should use the amount on the bill excluding VAT. However, if you're on the VAT Flat Rate Scheme and the accrual isn't for a large asset, you should use the amount on the bill including VAT.
If you’re unsure about how to record an accrual, please speak to your accountant.
On the first day of the new accounting period, you need to reverse the accrual to remove the value allocated to the earlier period from your profit and loss account in the current year.
To do this, navigate to the 'Accounting' tab at the top of the screen and select 'Journal Entries' from the drop-down menu.
Select ‘Actions’ on the right-hand side of the relevant journal entries and select ‘Reverse in new journal entries’ from the drop-down menu.
This will create a reversed set of those journal entries. Choose the beginning of your new accounting year as the date of the reversal - this is ‘01 Apr 21’ for the electricity bill example - and enter a description in the field provided.
Select ‘Create Journals’ at the bottom of the screen to complete the process. For more information on reversing journal entries, please see this article.
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