Accrual Accounting in Sage 50

Starting a business is an exciting ordeal. Most people anticipate major ups and downs, challenges, and a good deal of positive results at the end of it all. However, there are quite a few skills and ‘know-how’ that we need to equip ourselves with in order to have a better ‘hand’ in being able to better understand the ropes of the business. Understanding and knowing about Accrual Accounting in Sage 50. While most might wait until it is too late or they simply cannot avoid it. 

The good news is that learning about Accounting Skills is not all that difficult and can be easily mastered. Two accounting methods can help you a great deal: the cash accounting method and the Accrual accounting method. Here, one needs to know that each of these has its pros and cons. Also, the type of accounting that you select greatly determines the success of your business. As for the implementation of Accrual accounting, you will be able to get a truer picture of your finances and any other arising opportunities using this method. Now what is the Accrual Accounting method? Let us take a look:

The Accrual Accounting Method

Though many might perceive the Accrual Accounting method to be tough, nevertheless, it can be explained in a simpler form for a better understanding: 

Essentially with the help of Accrual Accounting, the revenue is calculated at the point when it is earned. Also, the expenses are accounted for when incurred, and it does not matter if the money has changed hands or not. While we are at it we can simply assume that it will at some point in the future. This is also the main difference between Cash Accounting and Accrual Accounting. The method essentially emphasizes the value of accounting as a periodic process, with that period also being a tax year. So by definition, the Accrual Accounting method can be defined as:

“ Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. The purpose of an accrual method of accounting is to match income and expenses in the correct year.”

This also offers the managers a clear insight into their businesses, as the expenses are linked explicitly to the income within a certain time frame; a phenomenon known as the ‘Matching Principle’. This is also the key component of the Generally Accepted Principles- GAAP. 

When it comes to your accounting, both the expenses and the income are separated by months, which is also an alternative to the Accrual method of Cash Accounting. It can get through to understand what is going on and can make the business appear better than it already is, as liabilities like credit are difficult to spot.

Read More-: Accounts Receivable and Accounts Payable in Sage 50

Let us take a look at some examples of Accrual Accounting:

Accounts Payable: Expenses example for Accrual Accounting

Smith & Co purchases $1,000 of raw materials from a certain supplier.

After the goods have arrived, the expenses have been recorded by the accounting department. This has been done even though the bills are yet to be paid because their supplier allows terms of 30 days.

In this case, the $1,000 debt is recorded as a liability within the company accounts.

Let us take a look at what the IRS states regarding the expenses under the accrual method of accounting:

[…] You generally deduct or capitalize a business expense when both the following apply.

• The all-events test has been met. The test has been met when:
• All events have occurred that fix the fact of liability, and
• The liability can be determined with reasonable accuracy.
• Economic performance has occurred.

Economic performance implies a specific and somewhat complicated meaning; as explained within IRS Publication 538. However, it is enough to know that, concerning goods or services, it’s when the goods or services have been provided.

There are certain recurring expenses that have a special rule. As stated in the example above, if the widgets are categorized as a recurring expense then one might be able to account for them in a tax year even if “economic performance” hasn’t occurred in that year.

Accounts Receivable: Revenue example for Accrual Accounting

Smith & Co use the raw materials to create widgets, which it sells for $3,000 to a different company.

The date has been used by the finance team to record the sale to $3,000 within the accounts receivable part of the accounting software.

Also, the $3,000 sale is recorded as an asset within the company accounts.

According to the IRS, the revenue for accrual method accounting is described in the following way:

“[…] you generally include an amount in your gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy.”

The amount is recorded by the accounting team even if the terms agreed have been known with the customer, which means the business will not receive the $3,000 payment until the next financial period, which could also be next month. 

This will be true even if the sale and receiving of the amount manages to fall across a tax year.

Should the Business Use Accrual Accounting?

This entirely depends upon the business you own; whether you should use cash or accrual method-based accounting. 

An important factor is if your business comprises inventories, which implies that the production, purchase, or sale of merchandise is a source of income for you.

You need to use Accrual accounting for your business. It requires you to take inventories into account at the beginning and end of the tax year. 

Cash accounting is much like a simpler option, and it especially is for smaller businesses (e.g. sole proprietors). However, it can only be utilized by businesses that pass the Gross Receipts Test. This certain rule has been set by the IRS, as follows:

“A corporation or a partnership meets the test if its average annual gross receipts for the 3 preceding tax years were $25 million or less (indexed for inflation)”

You need to note that this $25M threshold is relatively new. It has been increased from $10M in 2018 with the passage of Public Law 115-97 according to the Tax Cut and Jobs Act. 

In case you fail the Gross Receipts Test then you need to switch to accrual method accounting. This is a legal requirement. You need to do so in the tax year within which you fail to meet the test. In this case, you need to tell the IRS through form 3115.

How to Use Accrual Accounting Effectively

Accrual method accounting is perhaps the only effective choice for businesses once a certain level of complexity has been achieved. Most times this is related to business size but this is not the case always, and it can be wrong to assume that smaller businesses should always use cash accounting.

Essentially, this level of complexity might occur when additional staff has been employed, such as salespeople who work on commission which needs to be paid periodically.

Accrual method accounting can be important when your product or service offerings increase and you are left with multiple expenses that have to be accounted for and tallied to the revenue generated by them. This is specifically applicable when you start to purchase large quantities of specific or various items.

With the Accrual method of accounting you can better deal with bad debts, that are useful if your business is exposed to variable customers whose integrity you cannot always presume in advance. The accrual method also allows the use of bad debt reserve accounting in order to help cushion against non-payments, for instance, by providing better clarity into this type of liability than you might acquire with cash accounting.

Conclusion: Why Use Accrual Accounting?

The accrual method of accounting is one of the best things to consider and implement if you are aiming for a successful business that can grow and also show good results. 

 However, this is something that you are going to have to adopt sooner rather than later. Starting soon enough, therefore, makes sense and is also recommended. 

Likewise, the cash method accounting should only be applied by businesses that aim to remain at a specific level. A good example is a sole proprietor that offers local service and has the goal of offering themselves an independent income. For such an individual, who doesn’t want to get diverted down in any admin, the cash method makes perfect sense. 

As for the rest of us, the accrual method of accounting is simply the most sensible thing to apply. Moreover, it is a basic expectation that potential investors will need to observe. Not only does it offer the level of financial insight they require, but it also depicts that you’re taking your accounting and admin seriously. Also keep in mind that they are investing in you and your team, as much as they’re investing in the business created by you. 

Also Read-: Cash Flow in Sage 50

Accrual method accounting is tricky to learn and understand at first. Get in touch with CPA or other accountants if you require any assistance. However, once you have learned the basics, things fall into place quite smoothly. It is therefore important to consider the time spent learning as an investment for the success of your business.

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