Accrual principle

What it means

The accrual principle says a cost belongs to the period in which it was consumed and revenue to the period in which it was earned. When the money moved is a secondary matter for the result.

That is why double-entry bookkeeping uses accruals and deferrals, estimated items and provisions. Without them a year of rent paid in January would wreck the first month.

The opposite is the cash principle that single-entry bookkeeping and a sole trader’s tax records rest on: income and expenses are recorded when the money arrives or leaves. It is simpler, but the result for the year then depends on whether a customer paid on the last day of the year or two days later.

How it works in practice

At each monthly close it means accruing utilities, phones and services not yet invoiced, and spreading insurance and subscriptions across the months. Only then is the management report comparable with the month before.

The consequence is that profit and cash flow are never the same number. A company can be profitable with no money for payroll, or flush with customer advances while running a loss.

At the annual closing we go through the client’s contracts that run across the year end: annual licences, insurance, rent paid in advance, jobs still in progress at the balance sheet date. Each one is split into the part that belongs to the old year and the part for the new one. Without these papers from the client the split can only be estimated.

What to watch out for

The common error is posting a document by its payment or delivery date rather than the period it covers. A December invoice for November recorded in January shifts the tax base between two years.

The second problem is the mismatch with VAT. Value added tax follows its own rules on the tax point, which need not match the accrual principle: an invoice may be a December cost yet belong in the January VAT return. Whoever mixes the two logics and bends one to fit the other spoils either the result or the return.