Accruals

Prerequisites

Prior to reading the accrual instructions, it is beneficial to review the sections below to gain foundational information:

  1. Accounting Fundamentals
  2. Chart of Accounts and General Ledger
  3. Financial Statements

Preface

This section discusses a general understanding of accruals, how they impact the income statement and balance sheet, and how they are recorded within Indiana University. The information below walks through accruals, accrual accounting and why it is important. The section will also discuss the impact of the matching principle on recording accruals. Lastly, this section will specify IU’s requirements and best practices associated with posting accruals.


Introduction

Understanding Accrual vs. Cash Basis of Accounting

There are two main methods of accounting, accrual method and cash method. Indiana University is required to follow the Accrual method of accounting under US GAAP. Accrual accounting attempts to match the revenues an entity has earned in a period with the expenses that were incurred to generate the revenue. Simply put, if the revenue is earned in June, it is recorded to the income statement in June, regardless of when the entity received payment from the customer. This method differs from the cash method which records revenues and expenses only when monies are exchanged.

To illustrate the differences in these accounting methods, let’s review the following scenarios.

Scenario 1: On January 1, you sign a lease to rent space in a building. The monthly rental payment is $50,000/month but you decide to pay the rent for the entire year upfront for a total of $600,000.

Cash Basis - You would record this expense on 1/1, when you paid the $600,000.

Accounting Entry on 1/1:

Date Object Code Description Financial Statement Category Debit (DR) Credit (CR)
1/1 Rent Expense Expense $600,000
1/1 Cash Asset $600,000


Accrual Basis - You would record a prepaid expense in the month you paid the fee (i.e. $600,000) and then you would recognize a $50,000 expense for each subsequent month you use the building.

Accounting Entry on 1/1:

Date Object Code Description Financial Statement Category Debit (DR) Credit (CR)
1/1 Prepaid Rent Expense Asset $600,000
1/1 Cash Asset $600,000

Recognition of the $50,000 of rent expense on 1/31:

Date Object Code Description Financial Statement Category Debit (DR) Credit (CR)
1/31 Rent Expense Expense $50,000
1/31 Prepaid Rent Expense Asset $50,000


Scenario 2: On January 1, you agree to perform consulting services for a client to be completed over the next two years. Each month you agree to perform $30,000 of work on the client’s behalf. The client signs the fee agreement and pays you $720,000.

Cash Basis - You would record the revenue on 1/1, when you received the cash from the customer. Accounting entry on 1/1:

Date Object Code Description Financial Statement Category Debit (DR) Credit (CR)
1/1 Cash Asset $720,000
1/1 Service Revenue Revenue $720,000


Accrual Basis - You would record unearned revenue in the month you received the fees and then you would recognize the revenue when you actually perform the services for the client.

Accounting entry on 1/1:

Date Object Code Description Financial Statement Category Debit (DR) Credit (CR)
1/1 Cash Asset $720,000
1/1 Unearned Revenue Liability $720,000

Recognition of the $30,000 consulting services on 1/31:

Date Object Code Description Financial Statement Category Debit (DR) Credit (CR)
1/31 Unearned Revenue Liability $30,000
1/31 Service Revenue Revenue $30,000


Accrual Adjusting Entries

An accrual refers to an entry made in the books of accounts related to the recording of revenue or expense paid without any exchange of cash. In order to comply with the accrual method, an accountant posts an accrual adjusting entry for revenue that has been earned but is not yet recorded and expenses that have been incurred but are also not yet recorded into the general ledger. Note, accruals impact both the income statement and the balance sheet. Accruals are made via journal entries at the end of each accounting period, which within IU is done using an accrual auxiliary voucher document. They are done at the end of an accounting period so that the reported income statement and balance sheet can be inclusive of these amounts.

There are many types of accruals, but most fall under one of the two main types: revenue accruals and expense accruals.

  • Expense accrual: when services or goods have been received by an entity, but not yet paid for. At Indiana University, all BUY.IU purchase entries are automated, and the accounts payable accrual will be posted automatically. For example, a department purchased $500 of office supplies in June 202X but was not invoiced until July 202X – this expense occurred in the final period of the accounting year, but is not paid until the bill is received in the first period of the following year. As the expense was incurred but not paid for during the same fiscal year, a payable will need to be recorded. For IU’s current year financial statements to be complete, the following accounting entry will be recorded in the general ledger:

Object Code Description Object Code Debit (DR) Credit (CR)
Office Supplies 4100 $500
Accounts Payable 9045 $500


  • Revenue accrual: when an entity receives payment (cash receipt), but IU has not provided the services or goods. An example is a person prepaying for their IU basketball season tickets. If the season ticket pass amounts to $1,500 and is paid in August 202X, but the games do not start until December 202X, the ticket revenue will be deferred until the revenue is earned, i.e. the basketball games start. For the current year's financial statements to be complete (under the accrual method of accounting) the following accounting entry will be recorded in the general ledger:

Object Code Description Object Code Debit (DR) Credit (CR)
KFS Accounts Receivable 8118 $5,000
Ticket Revenue 0830 $5,000

Importance and Impact of Accruals

Accrual analysis is an important process because it helps fiscal officers and top management gauge levels of economic standing and ensure balances are in line with budgets by ensuring revenues and expenses are recorded in the correct period.

Accruals allow an entity to better determine the profitability for the period, since revenues and related expenses are matched in the same period. The principle that allows for expenses incurred during a period to be recorded in the same period in which the related revenues are earned is known as the matching principle. The matching principle is used to accurately record expenses within an accounting period. The proper recognition of expenses is important because it impacts how revenue is recorded. Under the matching principle, expenses and revenues that are related to one another should be recorded in the same period. Recognizing the expenses in the incorrect period will distort the financial statements and provide an inaccurate financial position of the entity.

To summarize, main reasons for completing an accrual adjusting entries are:

  • Allows for financials to be compared with other entities and to previous years
  • Provides more complete reporting of the entity’s assets and liabilities at the end of an accounting period
  • More realistic reporting of an entity’s revenues and expenses, and net income for a specific time interval such as a month, quarter, or year.
  • Provides a better representation of an entity’s overall financial health
  • Follows the required accounting standards and guidelines i.e. Generally Accepted Accounting Principles (GAAP) and Governmental Accounting Standards Board (GASB).
  • Ensures consistency within the financial reporting of the university


Period accruals, deferrals and other adjusting entries must be recorded prior to issuing period financial statements. Within Indiana University, this is usually on the 10th of each month. If the 10th falls on a weekend or holiday, the next business day would be the cut-off. Accruals are an important part of proper financial statement reporting which is utilized in both internal and external audit procedures. It is key to have the reports readily available for audit purposes. An entity’s inability to provide the requested information can adversely impact IU’s audit and potentially impact funding.


Recording of Accruals at IU

Accrual adjusting entries are entered manually into KFS via an auxiliary voucher accrual adjusting entry (AVAE). See Requirements & Best Practices for IU specific details. Examples of when to use this document include the accrual of revenues earned but not yet received, or recording expenses incurred, but not yet paid. This allows the entity to reflect the amount of revenue or expense incurred in the proper fiscal period and allows the matching of income with expenses. These entries automatically reverse in a subsequent period on a specified future date. The AVAE reversal date defaults to the 15th day of the month following the transaction posting; however, this date can be changed by the document creator if desired. For an example and more information of how an Auxiliary Voucher works, please see Training Documentation.

There are system generated and non-system generated accruals within IU. Since the university operates on the accrual basis, several of the material accruals are generated by the Enterprise Wide Systems (i.e. HRSM, Buy.IU and KFS). Examples of system generated accruals are included below.

System-Generated Accruals

HRMS

  • Salaries Payable (9050) - The posting of salaries, wages, and benefits to the labor ledger and the general ledger occurs when each payroll is closed. However, since the cash has not been paid out, the offset for payroll expenses is recorded as a salaries payable accrual. On payday, the entry to salaries payable is reversed and cash is reduced. For more information, please refer to the Payments to Employees section.
  • Bi-weekly Payroll Accrual (9050) -The Biweekly Payroll Accrual is an estimate of payroll expense for days worked in a month that have not been processed in payroll. This entry typically occurs in the last few working days of the month. Additional information can be found under the payroll accruals document in the standard operating procedures section.
  • Accrued Vacation & Sick Liability (9056 & 9058) - Annually, a calculation is made to record the university’s Accrued Vacation and Sick Liability. The entry is based on a number of factors including salary plan, age, years of service, rate of pay, and vacation balances. Typically, this entry is booked in the latter part of June and reversed in June of the following year. Liability amounts are recorded for vacation, sick, employer contributions for vacation and sick, and an employer contribution for Federal Insurance Contributions Act (FICA).

BUY.IU

  • Accounts Payable (9045) - To properly recognize expense when the good/service is provided even if payment has not been made, an accrual adjusting entry is posted as a liability. Accruals posted to object code 9045 are system generated and act as an offset to invoice expenses, credit memo credits, and cash disbursements entries recorded through BUY.IU. Users are not allowed to post entries to 9045. Liability is relieved when the ACH, Wire or payment is sent to the supplier.
  • Year-End Accounts Payable Accrual (9045) - During the AP Accrual batch job, BUY.IU identifies the invoice transactions posted to the General Ledger (GL) in July that had an invoice date on June 30 or prior. Those entries, which include actual expense and liabilities will be posted back to June (period 12). This process is repeated a second time prior to second close to capture additional BUY.IU invoices where the invoice was dated June 30 or prior. These transactions will be posted back to June (period 13). Users are not allowed to post entries to 9045 at year-end.

SIS

  • Tuition Accrual (Multiple) - To properly recognize the revenues and expenses related to tuition under the revenue recognition and matching principles, the portion of revenue and expense that is not yet earned, but had been received or expended, needs to be accrued and recognized over the academic year at the campus level. Tuition payments received that are to be deferred have an additional debit to a campus-level income account (offsetting the RC income account credit) and a credit to deferred revenue liability. Similarly, expenses that are to be accrued have an additional credit to a campus-level expense account (offsetting the RC expense account debit) and a debit to prepaid expense asset. In order for a student account transaction to participate in the accrual process, two conditions must be met. First, the item type must belong to an item type group (range of item types) defined for this purpose. Second, the revenue (if charge) or expense (if payment) account must have an IU fund type of GF, DS or RF. This condition effectively eliminates auxiliary accounts from the accrual process in SIS. For auxiliaries, only the journal set 1 entries are created, and they are passed the same month they are posted.
  • Unearned Revenue Accrual (9404) - When a student registers for classes, the SIS creates an entry to debit accounts receivable and credit unearned revenue. For example, for the Spring semester, registration opens in mid-October and payment is due in early January. Since a majority of the students register for the Spring semester prior to 12/31, a large receivable and offsetting unearned revenue (liability) is created from SIS. These amounts result in an overstatement of assets and liabilities. To correct this, the Office of the University Controller does an accrual adjusting entry to eliminate the receivable that pertains to the Spring semester; the offset being unearned revenue. This results in a balance in unearned revenue (as it pertains to tuition) consisting of payments made by students prior to 12/31 for the Spring semester. This entry is made to the face of the 2nd Quarter financial statement and not entered into KFS.

KFS

  • Depreciation (89XX and 51XX) - The principle of historical cost requires that capital assets are recorded at their original cost. However, as time goes by, the capital assets are not typically worth their original amount. In order to reflect this on IU’s financial statements, capital assets are depreciated their useful life. Depreciation Expense and Accumulated Depreciation are driven by information contained in the Capital Asset System and is calculated on the 3rd Thursday of each month (except for year-end). For more information, please refer to the Accounting for Assets Section.
  • Non-Student Accounts Receivable (8118) - These are funds owed to the university by outside entities that have received goods or services for which payment is expected. Under accrual accounting, to properly recognize revenue earned even if the payment has not been received by IU, an accrual is posted as a receivable balance. Specifically, this accrual includes all charges billed outside of the bursar system (SIS) to students, and charges billed to external parties. This entry is subsequently reversed when payment is received for the good or service provided.


Non-System Generated Accruals

Non-system generated accruals are accruals that are calculated and entered manually by the user when the period ends. These need to be calculated and entered manually into the system. For further information on use of non-system generated accruals reach out to the local campus and fiscal officer.


Requirements & Best Practices

In order to ensure the accuracy of the university and unit level (internal) financial statements, it is important that each entity follows the accrual accounting method and adjusts its accruals periodically.

This section outlines general requirements and best practices related to recording accruals. While not required, the best practices outlined below allow users to gain a better picture of the entity’s true financial health and help identify potential issues on a more frequent basis. This allows organizations to identify errors, mistakes, and pitfalls so that they can be remedied quickly and prevent larger issues in the future.

Requirements

Quarterly Activities:

  1. Review all system generated (automated) accruals for material accuracy and completeness. Fiscal Officers should understand the cause of any material variances. Additionally, Fiscal Officers should not duplicate any system-generated (automated) accruals
  2. Record any accrual adjusting entry over the IU specified threshold of $500,000 on a quarterly basis.
  3. Record accrual adjusting entries under IU specified threshold of $500,000 and ensure no system-generated (automated accruals) are duplicated.
  4. The RC fiscal officers should review any manual entries recorded within their RC or entity.
  5. Substantiate any balances that are a result of the accrual adjusting entries, refer to the substantiation section under closing procedures.


Best Practices

  1. Review all accruals posted during the quarter and ensure no manual accruals are required. If a manual accrual is needed, ensure the entry is posted on a monthly basis. Users should ensure that all accrual adjusting entries are subsequently reversed (the AVAE document is most commonly used).