Episode #58
Today, I’m going to go back to basics about why this podcast exists and do a deep dive into Accrual Accounting Procedures. I’ve spoken about the differences between Cash based and Accrual based accounting for preparing taxes, but I never have spoken about the bookkeeping procedures and why Accrual Accounting costs you, the business owner, more money on a monthly basis because the process, itself is a much longer one. I’m (fully recovered from tax season, I think) -- Paul Rosenblum.
Don’t forget to email me with any thoughts or comments about this episode or the podcast, always great to hear from you! Now to some accounting!
However, before we start, let me remind you that a cash-based accounting system accounts for money in/money out transactions. If there is a customer invoice, yes, the invoice must be created, but it’s only counted as revenue when the customer pays all or part of the invoice. Expenses are counted only after they are paid out.
In theory (and where I am in NYC), the bookkeeper can enter all transactions from the bank or credit card statements and categorize them appropriately, always having some questions for the business owner at the end of each month. Many bookkeepers perform their services in this way. Although the client MUST keep all receipts for audit purposes (and I tell every one of my clients this), I remind people that the books that I am creating are their books and we want them to be as accurate as possible.
As I have mentioned before, if you are in Canada, my bookkeeper friends tell me that if a client is audited and there is no receipt for a particular transaction, it’s deemed as a non-deductible expense. So, bookkeepers in Canada work with receipts so that they can actually see what was purchased before it’s entered in as a business expense. In the U.S., the IRS isn’t as strict, unless they want to be or have a reason to be.
Now let’s talk about Accrual Accounting. So, get a cup of tea (or a drink) and a note pad and be ready to take notes as I go through the process of month-by-month accounting using the Accrual method. I won’t pause here--- you can do that yourself, and press ‘play’ whenever you are ready 😊
Because Accrual accounting allows the bookkeeper and the tax preparer to accrue income and expenses to the next calendar year or from the current year to the previous year (if the tax return isn’t finalized or filed yet), the bookkeeping can be a lot more work, which will also mean more cost for the business owner.
I have only two companies who are on an Accrual basis. And I’m very happy about that!
Although a bookkeeper can put together the books all year on a cash basis, and then at the end of the year, make all of the accrual adjustments for tax purposes, we are going to talk about the monthly accruals, which is really the correct way of doing Accrual accounting.
Here is a checklist of regular accruals at the end of each month which must be done by the bookkeeper, and then we’ll go through the procedure for each one.
- Payroll accruals
- Accounts Payable
- Accounts Receivable
- Customer Deposits
- Prepaid Expenses (also on a cash basis)
- Credit Card Payables (Incoming)
Let’s go into each of these with more detail.
Payroll Accruals: If the payroll are all direct deposits into employees’ bank accounts, there should be no accruals because the direct deposits are deducted from the business bank account at the time they are created, not actually when the employee receives it, which could be one day later. However, (and I run into this with my accrual-based client) – if there are any paper payroll checks and any of those checks were not cashed in the same month as they were issued, then they have to be accrued.
If, for one example, a paper check was issued on August 27th, but as of August 31st, that payroll check was not cashed by the employee, then in accrual accounting, that would be considered a ‘Payroll Payable’ liability on the balance sheet. An adjusting entry should be made crediting Payroll Payable and debiting a payroll expense for the month of August, since it is considered an expense for that current month keeping in mind to reference the check number and employee in the memo of the adjusting entry. When the check is cashed and deducted from the bank account, then the Payroll Payable would be adjusted as a debit and the credit would be to the bank account to deduct from the bank account balance and allow the bank to be reconciled by the bookkeeper. The bookkeeper could make one journal entry for all paper paychecks that have not been cashed, or separate entries for each check and memo the check number in the adjusting entry. (You can probably guess which option I like – yes, separate entries for each payroll check if feasible).
Accounts Payable – Each incoming bill that comes in must be entered as a ‘bill’ in the accounting system. This would debit the expense (or whatever account it should be connected to such as a fixed asset, or a liability other than accounts payable), and credit the Accounts Payable account. This way, the expense shows up in the current month. When the bill is paid, the bookkeeper would use the ‘Pay Bills’ option to have the system debit the Accounts Payable and credit the bank account to subtract from the balance there. The tricky part here is that the bill payment would be a manual entry by the bookkeeper, and when the download comes in from the bank, it ‘should’ match up to the manual entry. Be careful, as a bookkeeper, not to have a double entry input, so be careful when reconciling the bank account every month. What I do is print out the Accounts Payable or ‘Unpaid Bills’ report to have in front of me so when I am going through the downloads, I can double check that I am catching everything and I don’t have double entries.
Accounts Receivable – When a customer invoice is entered, it automatically becomes an accounts receivable. The items on the invoice hit the revenue account as credit, and the debit is to Accounts Receivable. Like entering a bill and paying a bill, entering an invoice and receiving a payment when the payment comes in is essential in keeping good accrual books. Again, be careful when going through the downloads, as the payments that you have manually entered might not match correctly to the downloaded deposits on your bank feed.
Customer Pre-Payments – If a customer pays you in advance of you starting a job or a project, in accounting, it should be booked as a liability on the balance sheet called ‘Customer Pre-payments’ or ‘Customer Deposits’. The ‘item’ line on the customer invoice for customer pre-payments or deposits should be linked to a liability account, and not a revenue account. Like a retainer for lawyers, it is money coming into your bank account, but not revenue or a sale since it’s not earned yet. At the end of the month, any portion of any customer deposit that has been earned must be adjusted and put into revenue. That journal entry would be a debit to the liability and a credit to the revenue account being used, with customer names attached in the proper field.
Pre-Paid Expenses - Let’s use the example of a business liability insurance premium being paid in March of the current year for an entire year and it’s $1200.00 per year. You would be covered from April 1, 2025, through March 31, 2026. A bill would be entered for the entire amount in March of 2025, but not to an insurance expense. It would be entered in the ‘other asset’ account called “Pre-Paid Expenses’. The entire bill payment would be entered as normal when the bill is paid. At the end of each month, starting in April, $100.00 would be accrued. The entry would be credited to the pre-paid expenses and debited to the insurance expense account. That entry would be repeated every month throughout the year and the first 3 months of the next year. This way, the monthly reports would be accurate, and the true amount of insurance paid for the current year would be recorded.
Credit Card Receivables - If customers or clients pay you by credit card, you should have a credit card receivable in your chart of accounts. Depending on the company, it could be mixed in together with the ‘cash on hand’ asset account, which is what I do for a restaurant, for example. This would represent a customer paying your business with a credit card on the last couple of days of the month. If someone pays you on the 30th of Jan by credit card, it probably won’t hit your bank as a deposit until the first day of February. So, you want to show the sale as a January sale, with the deposit hitting the bank in February.
If you create invoices in the accounting system and don’t have a POS tracking sales, you could use the ‘Undeposited Funds’ account in QuickBooks. If the invoice is dated Jan. 30th, the customer pays you with a credit card on Jan. 31st, but the funds get deposited into your bank account on Feb. 1st, those funds can sit in undeposited funds so it counts as a collected, paid sale, and then the bookkeeper can go in and make the deposit on the date that it shows up in the bank account. You can also use a ‘Credit Card Receivable’ asset account if you want to separate cash and checks, Venmo, PayPal and Zelle Payments from credit card payments. Also don’t forget to count Venmo and PayPal funds coming in even if you haven’t transferred those funds to your bank account. They are still sales!
With all of that said, one of the biggest challenges since Covid started back in 2020 is that bookkeepers are working much more remotely now than they (we) used to. So, an internal system has to be designed for each client as to how the bookkeeper is going to get the unpaid bills to enter them into the system, and how the bookkeeper is going to get those same bills after they are paid. I have some clients using Dropbox, others use Google Drive, and others still using Email. Still others want to use texts, but I put my foot down there. Whatever works for the personality of the client and the business.
There are specific reasons to be on the Accrual basis rather than a cash basis. I have a client who ships products outside of the U.S. It takes 40 days for the client to receive it. The IRS says that an invoice is valid only after a shipped item is received by the purchaser. So, if my client has $100,000 of shipped merchandise outside of the U.S. in December, received in Jan. by their customer, then the entire $100,000 can be accrued to the next calendar year since the invoices are technically not valid in the current year. If you have a large job that you finished in the current year, but the client said that they will pay you in Jan of the next year with a wire transaction to be deposited into your bank account in Jan, then when you receive that wire, you can accrue that value back to the previous year so that you can close that job with revenue and the accounts receivable on that revenue in the same year. Or you can take that large project that you did in December of 2025 and accrue it to 2026, since you got paid in 2026. Some of that is based on the profit that you currently show in the books during the current year. At the end of the year, it’s very important to make sure that your accounts receivable and payable accounts are accurate, since those numbers will be used in your accrual accounting tax return.
And you business owners wonder why it costs so much more money for your bookkeeper to do accrual accounting rather than cash-based accounting?
Remember, keep receipts for everything, even though you might not provide your bookkeeper with them. I have clients keep the receipts and binder clip them to each bank or credit card statement that they have. Or you can use online software to scan the receipts in and store them on the cloud or even in QuickBooks online.
Let me know if you want more episodes like this, as a bookkeeper or a business owner. Email me at Bookkeepermensch@gmail or text message me here – the links are below.
Now go resume your day and digest all of this information -- I have given myself a headache talking about Accrual accounting for all of this time -- I’m going to do the bookkeeping on a simple cash-based company!
Happy Accounting and Bookkeeping! I’m Paul Rosenblum
