Last Day of the Accrual Cycle:

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Q: I have been with my company 30 years and have experienced many internal and external audits of AP. For as long as I have been doing AP, our policy has been to use the date the invoice was received as our guide for accruals. If the invoice was received no later than the last work day of the closing month and was over $1,000, it was accrued to the department charge number, and if the invoice was received on the first work day it was considered to be part of the current month even if the goods or services were provided in the previous month.

We recently changed auditors and they are questioning our accrual policy. If we continue to accrue after the last work day of the month, where do we draw the line as to when to stop accruing? It appears the logic the auditors are using would mean we couldn't close June books until August and that certainly isn't acceptable.

 

A: Your question depends on the basis of accounting that your company operates. There are two methods: (1) accrual basis accounting (2) cash basis accounting. If you are a publicly traded company then you are required to use the accrual method of accounting. By your question where you mention auditors we are assuming that you are on the accrual method of accounting.

If your firm is audited then you are required to follow Generally Accepted Accounting Principles (GAAP) that includes using the accrual method of accounting. In this case, you are required to recognize an expense at the time you either receive the materials/products or receive the benefit of a service. Your auditors are correct in the fact that if you receive the benefit of a service before the end of the month, then regardless of whether you have an invoice you are required by GAAP to record the expense. Many companies will do one of the following to accrue for the expense in the current period even if they don't receive the invoice until the following month:

  • Request an invoice from the vendor upon completion of the service,
  • If the item is associated with a purchase order (PO) then accrue for the amount documented in the PO, reverse the accrual in the following month, and record the actual when the invoice is received,
  • If no PO or invoice can be obtained, then the company estimates the value of the product or service received, you should be able to get this by calling your vendor or retrieving it from their product catalog, if the product or service is purchased on a regular basis then past amounts paid can be a reasonable guide for the accrual.

Some companies also attack the issue by setting up an "AP accrual reserve" account. This is done by determining the average value of vendor invoices received after the end of the month (but product or service relates to the prior month) that need to be accrued. This amount is used to set up an AP reserve for "accrued invoices." As long as the amount accrued in the "AP accrual reserve" is less or equal to actual value of vendor invoices received after the end of the month, then you are considered fully accrued.

We recommend working with your auditors to use an acceptable process that will achieve the correct accrual accounting and still allow you to close out on a timely basis.

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