Applying the accrual accounting basis

The accrual accounting basis ensures that revenue, expenses, liabilities, and assets are recorded in the book of accounts based on their timing rather than when cash is received or paid. The revenue recognition and matching concept are related to the accrual concept. More so, many of the IFRS standards use this accounting basis.

The accrual accounting principle is necessary in the preparation of financial statements excluding the statement of cash flows. We will consider two accrual accounting areas and their applications in the book of accounts and financial statements. 

Revenue

Revenue is recognized in the books of accounts following the five-step model in IFRS 15. Generally, the timing of revenue is when it is earned and not when it is received. Revenue is earned when the terms and conditions have been met by the entity. Although, the company may not have received cash. Where cash is not received, it results in receivables.

For example, Obaro Limited is in the food business, selling Jollof rice and chicken to its customers on June 10. A customer made an order for 100 plates of rice for 1,500,000 Naira. On June 15, the company fulfilled the order, but payment was not made by the customer until June 18. 

From here, Obaro Limited will recognize the sales on June 15 on an accrual accounting basis. The double entry is this:

• Dr: Trade Receivables
• Cr: Revenue

With the N1,500,000 for revenue earned.

On June 18, the entity received the payment. Therefore:

• Dr: Bank account
• Cr: Trade Receivables

With the N1,500,000 of cash received.

Note the timing. Revenue was earned when Obaro Limited supplied the goods to the customer on June 15. This creates a debt for the customer, referred to as trade receivables. When the payment was made on June 18, the trade receivables were cleared.

Another aspect is when the customer paid Obaro Limited on June 10th. In this case, the company has not made the food available to the customer; therefore, revenue cannot be earned or recognized in the book of accounts. Previously, this was referred to as deferred revenue or unearned revenue. 

However, with IFRS 15 it is called contract liabilities. Yes, it is a liability to the company as long as it hasn't delivered the goods. So the double entry shall be:

• Dr: Trade Receivables 
• Cr: Contact Liabilities 

With the amount on June 10 when the payment was made, but the goods have not been delivered to the customer.

But, when the goods are delivered to the customer on June 15:

• Dr: Contract Liabilities 
• Cr: Revenue

With the 1.5 million earned by the company.

I believe you noticed the timing. The company received the money on June 10, but it cannot claim revenue because the terms and conditions for the goods have not been completed. But on June 15, the money was earned and was removed from contract liabilities to revenue.

Expenses

Another area of application for the accrual accounting basis is expenses. And here we will look at rent and utility bills

For expenses, the accrual concept states that expenses are recognized in the books of accounts when it is incurred and not the date they are paid. You can see the timing here. The date it was incurred.

Rent Expense

For rent, the payment is usually in advance. That is, you pay for it before you start enjoying the benefits, or in other words, incur the expenses. Assume that Obaro Limited's annual rent is 12 million, and the owner of the property expects the company to pay on January 1 or not later than January 31st of the year. But the rent will run from January to December. 

The first thing is to divide the rent into a monthly rent of 1 million Naira per month. Next, every month, the one million Naira will be incurred for the next twelve months to complete the 12 million Naira. Now the double entry for this transaction is as follows

• Dr: Rent Prepaid
• Cr: Bank account

With the 12 million Naira paid by Obaro Limited to the Landlord on January 1st.

• Dr: Rent expenses
• Cr: Rent Prepaid

With 1 million Naira to incur the rent amount every month.

Utility bills

This is usually paid in the month after the service is enjoyed by the entity. In Nigeria, the PHCN brings in the bill after you have enjoyed the service. However, with the prepaid system introduced, companies can now pay for the service before enjoying it. 

When the utility or electricity bill is paid after enjoying the benefits, as it happens in a complex where the Landlord pays the bill and charges the businesses using the mail for it, then the accrual concept must be applied. In this situation, a monthly sum will be paid for utility bills. 

Obaro Limited pays 100,000 Naira monthly for election bills. This is paid on the 5th of the following month. The double entry for June 2025 will be as follows:

• Dr: Utility bills
• Cr: Accounts receivable

With the 100,000 Naira for the month. Although, the money is yet to be paid by the company. When the rent is paid on the 5th of July, 2025,

• Dr: Accounts receivable
• Cr: Bank account

With the 100,000 Naira paid by the company. 

Note that you do not have to wait for the company to make payment to reconcile the utility bills in the book of accounts. Ensure that they are posted to their accounts before he close of business for the month.

In conclusion, accrual accounting is one principle all preparers of financial statements must understand. Its application makes accurate financial reporting.