Understanding Over Accrue and Its Effects on Your Business

Over accruing can have severe consequences on your business, causing financial losses and reputational damage.

Inaccurate or incomplete accounting can lead to over accruals, which occur when a company records expenses or revenues before they are actually earned or paid. This can result in a distorted financial picture, making it difficult to make informed business decisions.

Over accruing can also lead to cash flow problems, as companies may be left with insufficient funds to meet their financial obligations. This can be particularly challenging for small businesses or startups that rely on a steady cash flow to stay afloat.

In some cases, over accruing can even lead to financial penalties or fines, especially if the company is found to be in violation of accounting regulations or standards.

Worth a look: When a Company Incurs Accrued Expenses

An accrual is a journal entry that estimates revenue or expense that has been earned or incurred but not yet recorded. Accruals are usually set up as reversing entries, which means they get reversed in the next accounting period.

An accrual can be for revenue or expense, and it's used to match income and expenses with the period in which they occur. For example, if a company provides services in January but gets paid in February, it would record an accrual for the revenue in January.

Accruals can be tricky, and sometimes they can be too high. This is called an over accrual. An over accrual of revenue will result in an excessively high profit in the period in which the journal entry is recorded.

Here are some examples of how over accruals can affect financial statements:

An over accrual is not good from the auditor's perspective, as it implies that a company's accounting staff is not able to properly estimate the amounts of revenues and expenses for which it is creating accruals.

Additional reading: If the Adjustment for Accrued Revenue Is Not Recorded

Accruals are a type of accounting entry that records an expense or revenue before it's actually received or paid. This can happen when a company pays for services or goods in advance, or when it estimates an expense based on historical costs.

Broaden your view: When Does Post Judgment Interest Begin to Accrue

To illustrate this, let's consider XYZ Company, which pays an external vendor for server maintenance. At the end of each quarter, XYZ Company accrues an estimated $10,000 for these services, based on historical costs. However, when the invoice arrives, the actual cost turns out to be $8,500, resulting in an over-accrual of $1,500.

To correct this, XYZ Company makes an adjusting entry in Q2, debiting Accrued Expenses and crediting Server Maintenance Expense by $1,500. This brings the accounts in line with the actual cost incurred.

Accruals can also be used to defer expenses, such as registration fees posted to the ledger in one fiscal year for a conference that will take place in the following fiscal year. This is required for items of $10,000 or more, and involves crediting the same Full Accounting Unit (FAU) used when the expense was paid, and offsetting it with a debit to Deferred Expense.

Here are some key facts to keep in mind when dealing with accruals:

To avoid over accruals, only make an accrual entry when the amount to be recorded is easily calculated.

If the amount is subject to fluctuation, the most conservative figure should be recorded.

You need to use deferred expense when you've paid for goods or services in advance, but the activity won't take place until the next fiscal year.

Registration fees posted to the ledger in one fiscal year for a conference that will take place in the following fiscal year is a good example of this.

To set up a deferred expense, you'll need to credit the same Full Accounting Unit (FAU) used when the expense was paid.

The account you'll use is 1143000, Deferred Expense.

The object code is 0801, also Deferred Expense.

You'll debit this account to recognize the expense in the correct fiscal year.

For instance, if you paid for catering services for an event in July of the next fiscal year in advance, you'll debit the Deferred Expense account.

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You'll also need to include the date the goods/services were received, vendor name, purchase order number or invoice number, and the date of the intended activity in the Explanation field.

A reversal date in the AVAE document is also required, and this should be greater than or equal to 7/20/200X.

The reversal of the AVAE will result in a debit to expense, appropriately moving recognition of the expense to the correct fiscal year.

Here are the steps to follow: