This rule states that expenditure must be matched with revenues earned.
Accounting Standard SSAP2 sets out several concepts which accountants are
required to follow, the accruals concept being one of these. The 'accruals
concept', or 'matching concept', requires that revenues are matched with
the relevant expenditure. This means that regardless of when the money
is paid or received for a transaction, the business counts all costs incurred
and this sometimes means that an estimate of costs has to be made.
The Accruals or matching concepts requires the following to be adopted.
Sales as recorded at
the top of the trading account, is the total value of sales invoices
raised for goods and services provided during the accounting period.
If the accounting
period is the year ended 31.12.1999, then the accounting period
is from the 1 January
1999 to the 31.12.1999. Sales invoices raised for goods and services
provided outside of
this period are NOT to be included in the sales figure for y/e 31.12.1999.
1.1.99
31.12.99
Do not include
Include
Do not include
All raised invoices for goods and services provided in the accounting period [In this example accounting period = y/e 31.12.1999] are included irrespective of whether cash has been received from customers or not. It is normal trading practice for customers to buy goods on credit terms. This means that they may delay paying for goods and services provided by the business. It is quite normal, therefore, to include in the sales figure ,sales invoices raised which customers still have not paid for by 31.12.1999. The total amounts owing to the business by its customers on 31.12.1999 will appear in the balance sheet as a current asset knows as Debtors.
This is a completely different approach to the Receipts and Payments approach which would require recording only cash/cheques received from customers as sales. Likewise on the purchases side, purchases and other expenses would [under the receipts and payments approach], be actual cash/cheques paid for goods and services purchased. Whereas under the accruals/matching concept we must include the cost of all goods and services purchased even those on credit terms and for which at the end of the accounting period the business still owes its suppliers. This amount still owing at the year end will appear under the current liabilities as trade creditors.
The matching concept requires
all costs incurred in achieving sales for an accounting period to
be matched against those sales.
Sales
1.1.99
31.12.99
31.12.00
| Sales
Purchases Rent Telephone Wages |
||
Likewise, if by the end of the year the electricity accounted for so far only covers a 6 months period, an estimate for the other 6 months period must be made and added on to the electricity charge in the profit and loss account. This estimate is shown in the balance sheet as a current liability and is known as an accrual.
The matching concept can
sometimes provide us with difficulties, when a large cost incurred in one
year ,benefits many accounting periods. For instance the cost of machinery
is expected to benefit sales in many accounting periods. Likewise Advertising
and Research and Development Costs could be said to benefit future accounting
periods. Strictly applying the matching concept would require us to estimate
what benefits in terms of sales would occur in future periods and then
to spread or match these costs appropriately against the future periods.
In order to help us decide how to account for these types of expenditure we need to understand SSAP2's Prudency concept. Prudency requires us to account for all possible liabilities and costs in an accounting period but not to anticipate sales and possible income. This means that we must make provision for all possible costs incurred. In other words instead of matching costs to future possible sales we are to account for them as soon as they arise. SSAP2 dictates that when the matching and prudency concepts conflict we must choose prudency. [Prudency Prevails!].
What does this mean for our advertising, machinery and research costs? Let us put machinery aside for one moment. The treatment for advertising is simple. It must be accounted for in the period when it is incurred and not in future periods when possible income may or may not be actually achieved. The accounting treatment for Research and Development is covered by a special accounting statement [SSAP13]. However, basically the rule is that it must be accounted for in the period when it is incurred. The only exception to this is expenditure called development expenditure which satisfies a number of strict criteria which are associated with significant assurances about achieving future sales.
Now let us look at machinery costs. This is a fixed asset and like all fixed assets it is governed by SSAP12 which states that all fixed assets except land and investment properties need to be depreciated. Basically this is SSAP12's way of adopting the matching concept. This is done by matching the value of fixed assets 'wearing out' or the bits 'used up' during the accounting period against that period in the profit and loss account. Each year the measure of wearing out [Depreciation] is calculated and deducted from profit in the profit and loss account. This value is also deducted from the cost of the fixed asset and is recorded in the balance sheet as cost less depreciation to give its net book value.
Each year the depreciation for the year is calculated, charged to the profit and loss account and deducted from cost. This deduction from cost is called accumulated depreciation and is made up of the total years depreciation charges to date. Net book value which is original cost less accumulated depreciation will therefore decrease every year. Let us assume that in the y/e 31.12.1999 machinery costing £10,000 was purchased and depreciation to be charged is £2,500 per year. The following results are obtained:-
Profit and Loss Account
Balance Sheet Accumulated
Net
Depreciation Charge for the Fixed Cost
Depreciation Book Value
year
Year 1 2,500
10,000
2,500
7,500
Year 2 2,500
10,000
5,000
5,000
Year 3 2,500
10,000
7,500
2,500
Year 4 2,500
10,000
10,000
0
Looking back at a different example of electricity, there had been
a charge of £3 for the quarter ending 31 March, and an estimate of
£2 for the quarter ending 30 June. If you look at the amount charged
in the profit and loss account for the period, you will see that the charge
for the six months was £5, i.e. £3 + £2. This estimate
of £2 for the second quarter is known as an accrual.
Kathryn paid Insurance premiums, on the premises for her flower arranging
business as follows:
Feb 29 19x2 £210 for the period 1.1. 19x2
to 31.3 19x2.
Aug 31 19x2 £420 for the six months to
30.9.19x2.
Nov 18 19x2 £420 for the period of six
months to 31.3.19x3
Which of the following should be the figure shown in the accounts
for Insurance for the year ending 31.12.19x2:
£1050
£ 630
£ 840
None of these? 
Kim
pays rent on his video rental shop of £1,000 per annum. His actual
payments during the year to 31.12.19x5 were:
31.3.19x5 £250, 7.7.19x5 £250, 28.10.19x5 £250.
How much should be shown in the accounts for shop rental for the year ended 31.12.19x5?
Will the amount outstanding be an accrual, or a prepayment?
How much should the outstanding amount be?
Accruals, therefore, are an extra cost which needs to be charged
to the accounts for a particular period to ensure that those costs match
the revenue which has been earned in that period. Prepayments are monies
paid in the current accounting period for goods or services which will
be used by the business in the following period. Therefore, such prepayments
need to be excluded from the costs in the current period.
try another question?
Learning more about the Matching
or Accruals concept :Answers
The answer is £840
The year ended 31st December 19x2 incurrs the following costs:
£210 + £420 + half of the November
payment of £420
return to question?
Learning more about the Matching
or Accruals concept :Answers
£1,000 is the rental charge for the year
Acrrual. He has only payed £750 and so £250 is outstanding
£250 is therefore the outstanding amount
return to question?