I was thinking the other day that if a man is an ape that can walk upright, then an accountant is a man who can use the accruals principle. It’s an evolutionary thing!
This accruals idea keeps accountants in business, it leads to them producing reams and reams of accounting rules and regulations and keeps the rest of the world in awe of them and the strange adjustments they make to their figures.
The idea is that expenses and income show up in the Profit and Loss account (or Income & Expenditure statement in the public sector) in the period when they are incurred or earned. It works the same way as your credit card statement. I’ve just got mine for August this year. It looks a bit like this:
- P&O Ferries 38.00
- La Forge de Ste Marie 137.48
- Aire de Jacques Tattie 75.30
- Cafe de Marcelle 48.15
- Camping Chateau de Poinsouze 115.32
That’s right, I went to France on my holidays in August and very nice it was indeed, by the way. We particularly enjoyed the camp site at the Chateau de Poinsouze in the Limousin where the faciulities were of the highest standards (very important to me and the wife).
The thing is that I won’t pay for these expenses until the end of this month or the start of next month. It may be that I even put off paying some of it until November but whenever I get around to paying it the fact of the matter is that I incurred those costs in August. So if I was doing a Profit & Loss account for La famille Carlyle (that’s French for the Carlyle family), which month would I put these expenses in? Does it make a difference when I pay for them?
The answer is that it makes a difference to my cash flow when I pay for them, but it wouldn’t make any difference to my Profit & Loss/Income & Expenditure statement because I incurred the costs in August and therefore they should appear in August’s P&L/I&E. The reason is that I got the benefit from these things in August; that’s when I used them and that’s when I enjoyed them. If my P&L/I&E is telling the story of what I did (how I ‘performed’) in August then it should show that I incurred some expenses relating to my French holiday in August’s P&L/I&E.
It’s a good job that I don’t actually produce a P&L/I&E for the family, but the idea outlined above is the one that all businesses and public sector organisations struggle with every month end. That is, they want to make sure that their P&L/I&E records the activity that has taken place in the month as opposed to the amount of cash they’ve spent.