Accrual Basis, Estimates and Periods
Accrual Basis, Estimates and Periods
Cash answers when; accrual answers what period
During December, Northstar:
| Event | Cash in December | December accrual effect |
|---|---|---|
| Receives £24,000 for maintenance from January to December next year | +24,000 | Contract liability +24,000; no service revenue yet |
| Uses electricity estimated at £3,200, billed in January | — | Expense +3,200; accrued liability +3,200 |
| Pays £12,000 for insurance covering December–November | −12,000 | December expense £1,000; prepayment £11,000 |
| Uses production equipment; monthly depreciation is £2,500 | — | Expense +2,500; accumulated depreciation +2,500 |
December cash flow from these four events is +£12,000. December profit effect is −£6,700. Neither figure is “more true”; they answer different questions.
The four common timing patterns
| Cash timing | Economic activity | Initial account | Later entry |
|---|---|---|---|
| Cash first, expense later | Prepayment | Asset | Dr expense; Cr prepayment |
| Expense first, cash later | Accrual | Liability | Settle liability when paid |
| Cash first, revenue later | Customer advance | Contract liability | Dr liability; Cr revenue |
| Revenue first, cash later | Credit sale | Receivable or contract asset | Collect or reclassify later |
Matching without the myth
Students often learn “match costs to revenue.” That is useful shorthand, but it is not permission to create an asset merely to smooth profit. Under the Conceptual Framework, expense recognition follows changes in assets and liabilities.
Example:
- Cost of a delivered bike leaves inventory and becomes cost of sales because the inventory resource is consumed.
- An advertising campaign is not carried forward merely because managers expect future sales; it must satisfy the relevant asset requirements.
Estimates are part of accrual accounting
Depreciation, expected credit losses, warranty provisions and net realisable value use estimates. A defensible estimate states:
- the measurement objective;
- the evidence available at the reporting date;
- the method and assumptions;
- sensitivity to reasonable alternatives;
- what changed since the prior estimate.
A new estimate based on new information is normally applied prospectively. Correcting a prior error is a different issue.
Period-end checklist
Ask whether Northstar has:
- delivered goods or services not yet invoiced;
- received goods or services not yet billed;
- paid or received cash for future periods;
- consumed long-lived assets;
- experienced loss indicators or changed estimates;
- omitted cut-off items near the reporting date.
Quick check
Northstar pays £36,000 on 1 October for 12 months of rent. What appears at 31 December?