Accrual Accounting and Accrual Budgeting

Accrual Budgeting – Tarun Das
Accrual Accounting and Accrual Budgeting-

Basic Concepts and Methodology
Prof. Tarun Das1, Ph.D.
1
Glocoms Inc. (USA) Strategic Planning Expert, ADB Capacity Building Project on
Governance Reforms. For any clarifications contact das.tarun@hotmail.com.
Glocoms Inc. (USA) 1 MOF, Govt. of Mongolia

CONTENTS
1 Introduction
1.1 Cash and Accrual Accounting

1.2 Accrual Accounting in Developing Countries
1.3 Accrual Accounting and Economic Statistical Systems
2 Government Accounting Systems

2.1 A simple example of accrual accounting
3 An Operational Cash Plus Accrual Accounting System
3.1 Accrue wages earned by employees but not yet paid to them.
3.2 Accrue Pension and Health insurance contributions due
3.3 Record interest expenses on a mortgage or loan and update the loan balance.
3.4 Record prepaid insurance.
3.5 Adjust books for inventory on hand at period end.
3.6 Accrue interest income earned but not yet received.
3.7 Record depreciation expense.
3.8 Adjust for bad debts or contingent liabilities
3.9 Accrue dividends payable if a corporation.
3.10 Accrue zero coupon bonds
3.11 Accrue income taxes payable if a corporation.
3.12 Account for the sale of fixed assets.
3.13 Set up accounts receivable balance
3.14 Set up accounts payable balance
3.15 Preparing Financial Statements
3.16 Converting accrual profits to cash flows
3.17 Projecting cash outflows
4 Status of Accrual Accounting in OECD Countries
5 Pros and Cons of Accrual Accounting

5.1 Benefits of Accrual Accounting
5.2 Critique of Accrual Accounting
5.3 Concluding observations
SELECTED REFERENCES

1. Cash and Accrual Accounting
There are two basic accounting methods- cash and accrual (sometimes called cash basis
and accrual basis). The major difference between cash and accrual is that under a cash
method, income and expenses are recorded at that point in time when money is actually
received or paid. In contrast, under an accrual method, incomes and expenditures are
recorded at the time when the economic value is created, transformed, exchanged,
transferred, or extinguished irrespective of the time of cash receipts or cash payments.
In a nutshell, cash method and accrual method differ only in the timing of when
transactions are credited or debited to the financial accounts. Under the accrual method,
transactions are counted when the order is made or the item is delivered or the services
occur, and it does not matter whether the money is actually received or paid. Under the
cash method, income is not counted until cash (or a bank instrument) is actually received,
and expenses are not counted until they are actually paid.
Cash Method Accounting
The cash method of accounting is very simple to use, because it's usually obvious when
money comes in or goes out. By contrast, the accrual method requires to recognize
transactions when they occur, not necessarily when the cash flows. Besides, for accrual
accounting, both the payments and receipts for financial and non-financial assets are
required to be recorded at the prevailing market prices and not by the face value.
Under both cash and accrual accounting, the purchase price of capital assets must be
depreciated or amortized over a number of years. Similarly, if some advance payments
are made for an expense that applies beyond the end of the current year, the payments
must be prorated and deducted proportionately over the period for which the payments
apply. This applies for payments for insurance and repayments of loans.
Advance lease payments must be deducted in the year to which they apply, and amounts
paid to acquire a lease from another lessee must be deducted evenly over the course of
the entire lease.
Accrual Method Accounting
The accrual method is the more commonly used method of accounting for business
enterprises. Under the accrual method, incomes from the sale of goods and services are
recorded when the sale occurs; and expenses are recorded when goods or services are
received, even though actual payments may take time. To be more precise, under the
accrual method, an item of income is recognized when all the events that establish the
right to receive the income have happened, and when the amount of income is known
with reasonable degree of accuracy. If the estimated and recorded amount differs from
the amount eventually received, then an adjustment is made to the income when the
payment is actually received.

Similarly, an item of expense is recognized when one becomes liable for it, it does matter
whether the amount is actually paid or not in the same year. Becoming liable means that
all events have occurred that establish obligation for payments.
Thus, the accrual method provides a more accurate picture of the fiscal balance than the
cash method, because incomes are recorded on the books when they are truly earned, and
expenses are recorded when they are incurred.
Basic differences between Cash and Accrual Accounting are indicated in the
following table:
Table-1: Differences between Cash and Accrual Systems

1. Cash accounting records receipts when 1. Accrual accounting recognizes events and
cash is banked and payments when cash is transactions when they occur, regardless
paid. of when cash changes hands.
2. Only a cash flow statement is prepared 2. Under accrual accounting2—in addition to

under cash accounting. the cash flow statement— two key
financial statements are presented:
2.1 Operating Statement: Shows the

financial results of an organization
during a period.
2.2 Balance Sheet: Shows all assets and
liabilities at a certain point in time,
providing insights on the
organization’s long-term financial
sustainability.
Hybrid method or Cash plus Accrual method
Hybrid method means use of accrual accounting to the extent possible and use of cash
accounting for the remainder of incomes and expenses.
1.2 Accrual Accounting in Developing Countries
Figure-1 illustrates common government levels and sectors. Historically, budgeting and
accounting methods generally differ among sectors. For example, central government
agencies generally use cash accounting while provincial and local governments, public
sector enterprises, and statutory bodies prepare accrual-based reports.
2
International accounting standards require the preparation of four primary key statements: (i)
Statement of Financial Position (balance sheet); (ii) Statement of Financial Performance
(operating statement, income statement or profit and loss account); (iii) Statement of Changes in
Net Assets/ Equity; and (iv) Cash Flow Statement.

1.3 Accrual Accounting and Economic Statistical Systems
Government accounting systems determine how financial and statistical information is

prepared and presented. Presently, governments of most developed countries adopt some
forms of accrual accounting for their budgeting and reporting financial statements. All
major international statistical systems such as the United Nations National Accounts
(NAS), World Bank Global Development Finance (GDF) and the International Monetary
Fund (IMF) Government Finance Statistics (GFS), Balance of Payments (BOP), External
Debt Statistics (EDS) and Monetary and Financial Statistics (MFS), and the International
Accounting Standards (IAS) are now on the accrual basis. These systems are described
briefly as follows:
(1) The European Union (EU), International Monetary Fund (IMF), OECD, United
Nations (UN) and World Bank jointly publish the System of National Accounts
(SNA). It compiles aggregate financial statistics for an entire economy;
government and private sector activities are combined together.
(2) The IMF Government Finance Statistics (GFS) is a specialized system intended to
support public sector financial and fiscal analysis.
(3) IMF also produces balance of payments statistics and monetary and financial
statistics on the basis of accrual accounting.

(4) The International Federation of Accountants (IFAC) introduced International

Public Sector Accounting Standards (IPSAS) in 2000. They are designed for use
in the preparation of general purpose financial reports by public sector entities
(individual government agencies or the whole government).
These international systems have slightly different purposes. Figure-2 illustrates

differences in coverage. Many developing countries are also either moving or considering
moving from cash accounting to accrual accounting.
Accrual Budgeting and Its Relevance for Developing Countries
SNA, GFS and IPSAS have been developed and radically revised in the past decade, and
all these systems are now based on accrual accounting. The European System of
Accounts (ESA 1995) also mandates accrual-based financial reporting. The following
subsections describe the three international systems.
System of National Accounts
Most recently revised in 1993, SNA comprises an integrated set of macroeconomic

accounts, balance sheets and tables based on a set of internationally-agreed concepts,
definitions and accounting rules. It provides an accounting framework within which
economic data can be compiled and presented in a format that supports economic
analysis and policy making. SNA also acts as a reference point for establishing standards
for related statistics and harmonizing other statistical systems such as balance of
payments, GFS, and financial and monetary statistics (FMS). Furthermore, it introduces a
set of new accounts such as environmental accounts.

Government Finance Statistics
The IMF released a revised GFS Manual in 2001, which introduces accrual accounting,
balance sheets and complete coverage of government economic and financial activities.
Although only a few countries are currently capable of meeting the standards
promulgated in this Manual, the number is increasing steadily.
International Public Sector Accounting Standards
IFAC began issuing accrual-based IPSAS in May 2000. They are based on the private
sector International Accounting Standards (IAS). Entities applying the accrual-based
IPSAS must also prepare cash flow statements in accordance with IPSAS 2 Cash Flow
Statements. Given the development, it is not surprising that, as of December 2002, few
countries directly referred to IPSAS for their public sector reporting.
2. Government Accounting Systems
The public and private sectors both used cash accounting until the 16th century. While
government accounting remained on a cash basis, the private sector developed Generally
Accepted Accounting Principles (GAAP)—including accrual accounting—for more
transparent information by lenders and better management information for price setting.
However, there were no such pressures on the government as it is not guided by

commercial motives but by wider objectives of equity, justice and poverty reduction.
Besides, government has power to raise resources through creation of money and
imposition of more taxes and duties. It is also accountable to a wider group of
stakeholders. Furthermore, public sector activities are closely scrutinized by the
executives and legislatures through the mechanisms of Budgets and Appropriations.
2.1 A Simple example of Accrual Accounting
Using a simple example3 for a small government, Table-2 illustrates differences between
cash and accrual accounting for a period of one week. Particularly, the way in which
pension obligations are treated is very informative4. Cash accounting ignores the $30
million pension obligation (in present value terms) until the pension payments are
actually made usually after many years. But, the accrual accounting immediately
recognizes the obligation as an expense.
3
Example is taken from Lakshman Athukorala, S. and Barry Reid (2003) Accrual
Budgeting and Accounting in Government and its Relevance for Developing Member
Countries, Asian Development Bank, Manila.
4
In keeping with most government pension scheme arrangements, the example assumes that
pension obligations are unfunded.

The effects of the following five transactions are shown in the financial statements:
(1) Corporate taxpayers are required to make tax payments of $100 million, but govt
received only $90 million. At the end of the week, $10 million is outstanding.
(2) The government sells fixed assets (valued at $100 million) for $100 million.
(3) Government paid salary during the week. In addition to paying employees $60
million, the government is obligated to provide for their pensions when they
retire. Employees earned $30 million in future pension rights during the week.
(4) The government settles an old legal dispute. It agrees to pay $30 million to the
plaintiff in 2 months’ time.
(5) All the government’s borrowings (amounting to US$500 million) are held in
foreign exchange. The exchange rate depreciated by 2% during the week.
It may be observed from the table that the Cash accounting shows a surplus of $130
million, while the accrual operating statement shows a deficit of $30 million. The $160
million difference arises from the fact that cash accounting ignores the pension liability
($30 million), the asset already had a value equal to its sale price ($100 million) and
therefore no gain in revenues on accrual accounting, the exchange rate change ($10
million), the judgment liability ($30 million), and the taxes to be received ($10 million).
Table-2 Accrual Accounting
Cash flow statement Operating statement Balance Sheet

Opening Changes Closing
Receipts: Revenues Assets
Taxation a 90 Taxation a 100 Banks 50 130 180
Asset sales b 100 Receivables 20 a 10 30
Fixed assets 700 b -100 600
Total 770 40 810

Payments Expenses Liabilities
Salaries c -60 Personal costs c 90 Litigation 0 d 30 30
Foreign exchange Pensions 0 c 30 30
Loss e 10 Borrowing 500 e 10 510
Litigation
Expense d 30
Total 130 Total 500 70 570

Cash surplus 130 Accrual deficit -30 Net assets 230 -30 240
Bank balance Equity and reserves 270 30 240

Opening 50
Closing 180

3. An Operational Cash Plus Accrual Accounting System
It has been mentioned earlier that Hybrid method means use of accrual accounting to
the extent possible and use of cash accounting for the remainder of incomes and
expenses. In general, all countries first adopt a cash plus accrual accounting system
before migrating to a full fledged accrual system. Some of the ways to develop a Cash
Plus Accrual Accounting system are described below:
Single- or Double-Entry Accounting
The double-entry system provides checks and balances to ensure that the books of
accounts are always in balance. In double-entry accounting, every transaction has two
entries: a debit and a credit. Usually, one of the entries is a balance sheet account. Entries
that are not made to a balance sheet account are made to an income account or expense
account. Income and expenses affect the net income, which ultimately affects owner's
equity or net worth. As debits always equal credits, double-entry accounting prevents
some common bookkeeping errors. Many accounting software programs are available,
where one has to make only single entry for a transaction, and the software will
automatically make the second entry.
Adjusting Entries
Certain end-of-period adjustments must be made when books are closed. Some adjusting
entries are straightforward. Others require judgment and some accounting knowledge.
The following are some examples
3.1 Accrue wages earned by employees but not yet paid to them.
3.2 Accrue Pension and Health insurance contributions due
3.3 Record interest expenses on a mortgage or loan and update the loan balance.
3.4 Record prepaid insurance.
3.5 Adjust books for inventory on hand at period end.
3.6 Accrue interest income earned but not yet received.
3.7 Record depreciation expense.
3.8 Adjust for bad debts or contingent liabilities
3.9 Accrue dividends payable if a corporation.
3.10 Accrue zero coupon bonds
3.11Accrue income taxes payable if a corporation.
3.12Account for the sale of fixed assets.
3.13Set up accounts receivable balance if books are maintained on a cash basis.
3.14Set up accounts payable balance if books are maintained on a cash basis.
3.1 Accruing Wages Payable
Suppose on 31 December 2006, a department has not paid the employees one week of
salary amounting to 100 MNT (Million Tug) that will be paid on 7 January 2007. Make
the following general book entry for the accounting year 2006:
Debit (MNT) Credit (MNT)

Wages expense 100
Accrued wages 100
To accrue wages owed but unpaid on 31/12/2006
3.2 Accruing Pension and Health insurance contributions
Suppose on 3 January 2007, government deposited Pension and benefit contribution and
Health insurance contributions amounting to 1000 MNT due as of 31 December 2006.
One-half of that (500 MNT) is the government’s share that has not yet been recorded on
the books of accounts. We have to make general journal entry as follows:
Debit(MNT
Credit (MNT)
)
Pension and benefit contribution and
500
Health insurance contributions expense
Pension and benefit contribution and
500
Health insurance contributions payable
To accrue employer share of taxes owed but unpaid on 31/12/2006
3.3 Adjusting Interest and Loan Balances
Assume that government makes a monthly mortgage payment of 50 MNT for a building
taken on mortgage. Each monthly payment is part interest (20 MNT) and part principal
(30 MNT). If the correct amounts of interest and principal are recorded in the cash
disbursements journal every month, no adjusting entry would be necessary. An example
of such a cash disbursements journal entry is given below:
Debit Credit
Interest expense 240
Mortgage payable 360
Cash 600
3.4 Prepaid Insurance
Suppose a department paid an annual staff car insurance premium of 12 MNT on

September 1, 2006 for a fleet of staff cars, and charged the 12 MNT to insurance expense
in the cash disbursements journal. As of December 31, 2006, department has used up just
four months (4 MNT) of this coverage, and have eight months of coverage for 2007. The

eight months of prepaid coverage (8 MNT) represents an asset to the department. We

need to make the following general journal entry:
Debit Credit
Prepaid staff car insurance 8
Staff car insurance expense 8
To set up eight months of prepaid insurance on 31/12/2006
3.5 Adjusting Entry for Inventory
On December 31, 2006, a department physically counts the inventory items it has on
hand, and determines that the total cost of the departmental inventory as on December 31,
2006 is 180 MNT. Looking back at the general ledger, it is observed that the year started
with a December 31, 2005, inventory cost of 150 MNT. We need to make the following
general journal entries to update inventory:
Debit Credit
Purchases 150
Inventory 150
To clear out beginning (1/1/2006) inventory
Debit Credit
Inventory 180
Purchases 180
To book ending inventory at 31/12/2006
3.6 Accruing Interest Income Receivable
An Agency has a one-year, 1000 MNT certificate of deposit that it purchased on May 1,
2006 from a financial company. The company pays simple interest, at 6 percent, at the
end of its term on April 30, 2007. As of December 31, 2006, the agency has earned 40
MNT which is eight months of interest (1000 x 6% x 8/12). Agency should make the
following adjusting entry:
Debit Credit
Interest receivable 40
Interest income 40
To record eight months' accrued interest on 31/12/2006

3.7 Recording Depreciation Expense
An Agency has equipment and a building for carrying out its business. Using a
depreciation schedule, the accountant determines that the current period depreciation is
35 MNT on the equipment, and 25 MNT on the building. The Agency needs to make the
following adjusting entry to record depreciation expense and update the accumulated
depreciation accounts:
Debit Credit
Depreciation expense 60
Accumulated depreciation equipment 35
Accumulated Depreciation building 25
To record depreciation for the period ended 12/31/04
3.8 Adjusting for Bad Debts or Contingent Liabilities
Suppose a Department has lent money to a public sector enterprise which has become
sick and is unable to repay the loan. Since the Department had rarely any trouble in
getting the repayment of loan, it did not set up a reserve for bad debts. However, as the
Department reviews accounts receivable at year end, it notices that a particular Agency,
now insolvent, still owes 750 MNT. The Department is certain that this money will never
be paid. It is necessary to write off this account by making the following adjusting entry:
Debit Credit
Bad debt expense 750
Accounts receivable 750
To record bad debts for the year ended 31/12/2006
3.9 Accruing Dividends Payable
An Agency declares a dividend of 100 Tug a share on December 31, 2006. There are one
million shares of common stock outstanding. The dividend will be paid on January 15,
2007. It is necessary to make the following adjusting entry:

Retained earnings 100
Dividends payable 10,000
To record dividends payable as of 31/12/2006.

3.10 Accruing Zero Coupon Bonds
3.11 Accruing Income Taxes Payable
Suppose, an agency has made four estimated income tax payments of 5 MNT each for its
calendar-year 2006 tax liability. These payments were each recorded during the year in
the cash disbursements journal as follows:

Reserve for income. tax 5
Cash 5
Since the four payments were made during the year, there is a debit balance of 20 MNT
(3 MNT x 4) in the reserve for income tax account on December 31, 2006. The Agency’s
corporate income tax return for the year ended December 31, 2006, has been completed,
and it shows a tax liability for the year of 25 MNT. Since the agency has already paid in
20 MNT, Agency has to pay additional amount of 5 MNT to the Revenue Department. It
is necessary to make the following adjusting entry to reflect the income tax expense for
the year and the amount of tax owed to the Revenue Department at year end:

Debit Credit
Income tax expense 25
Reserve for income tax 20
Income taxes payable 5
To record income taxes for the year ended 31/12/2006
3.12 Adjusting for Sales of Fixed Assets
On March 4, 2006, a department sold a government building for 50 MNT. At the time of
the sale, the department made the following entry in the expenditure and receipts
accounts:
Debit Credit
Cash 50
Gain on sale of asset 50
The building had a cost of 40 MNT. As of December 31, 2005, department had taken 25
MNT of accumulated depreciation on the building. The adjusted basis cost of the building
is 15 MNT (40 MNT cost minus 25 MNT depreciated). Therefore, the Department has a
gain of 12 MNT on the sale (50 MNT received minus 38 MNT basis). It is necessary to
make the following adjusting entry to take the building off the books and reflect the
correct amount of gain (or loss) on the sale:
Debit Credit
Gain on sale of asset 15
Accumulated depreciation building 25
Building 40
To adjust for sale of truck on 31/12/2006
3.13 Adjusting Year-End Receivables
Assume that an Agency keeps its books on the cash basis, but its financial reporting and
tax returns are done on the accrual basis. The Agency adds up its accounts receivable
ledgers and finds that its total receivables are 16500 MNT on December 31, 2006. The
Department’s accounts receivable balance on December 31, 2005, which is currently
shown in the general ledger, was 13950 MNT. The Department needs to make the
following adjusting entries to update the year-end accounts receivable balance:
Debit Credit
Sales 13,950
Accounts receivable 13,950
To clear out 1/1/2005 accounts receivable balance
Debit Credit
Accounts receivable 16,500
Reserve for income tax 16,500
To set up 12/31/2004 accounts receivable balance
3.14 Adjusting Year-End Accounts Payable
Assume that an Agency keeps its books on the cash basis, but its financial reporting and
tax returns are done on an accrual basis. The Agency adds up its accounts payable ledgers
and finds that its total payables on December 31, 2006, are 2650 MNT, consisting of
merchandise purchases of 2100 MNT, equipment repairs of 330 MNT, and an electricity
bill for 220 MNT. The Agency’s accounts payable balance on December 31, 2005, which
is currently shown in the general ledger, was 1500 MNT. It looks at the adjusting entries
for last year and finds that at the end of 2005 it owed 1000 MNT for merchandise
purchases, 180 MNT for advertising, and 320 MNT for a utility bill. The Agency needs to
make the following adjusting entries to update the year-end accounts payable balance:
I Debit Credit
Accounts payable 1,500
Purchases 1,000
Advertising 180
Utilities 320
To clear out 1/1/2006 accounts payable balance
Debit Credit
Purchases 2,100
Repairs and maintenance 330
Utilities 220
Accounts payable 2,650
To set up 12/31/2006 accounts payable
3.15 Preparing Financial Statements
The standard financial statements include the following:

• a balance sheet
• an income statement
(a) Balance Sheet
Also called a statement of financial position, a balance sheet is a financial "snapshot" of a

business at a given date in time. It lists all assets, liabilities, and the difference between
the two, which is the owner's equity, or net worth. The accounting equation (assets =
liabilities + net worth) is the basis for the balance sheet.
The following is an example of a balance sheet for a small company:
ABC Company
Balance Sheet
December 31, 200X
Assets Liabilities and Capital
Current Assets Current Liabilities
Cash $12,300 Accounts payable $ 8,900
Accounts receivable 22,900 Wages payable 11,525
Inventory 32,090 Total Current Liabilities $20,425
Prepaid Insurance 2,500 Long-Term Liabilities
Total Current Assets $69,790 Bank Loan Payable 17,500
Fixed Assets Total Long-Term Liability 17,500
Equipment 100,200 Total Liabilities 37,925
Less: Accum. Deprec. (78,321) Capital
Total Fixed Assets 21,879 Tom Beta, Capital 53,744
Total Assets $91,669 Total Liabilities/Capital $91,669

Suggested General Ledger Accounts
A list of common general ledger accounts is shown below. Depending on the type of an
Agency, it will use many, but probably not all, of these account names. On financial
statements, they should generally be placed in the order shown.
(A) Balance Sheet Accounts:
Assets:
• petty cash (if you maintain a petty cash fund)

• cash in checking (a separate ledger account for each bank account)
• cash in savings
• accounts receivable
• reserve for bad debts
• inventory
• prepaid expenses
• office supplies (if you maintain a significant amount of office supply inventory)
• utility deposits
• notes receivable
• investments
• organization expenses
• vehicles
• accumulated depreciation — vehicles
• furniture and fixtures
• accumulated depreciation — furniture and fixtures
• equipment
• accumulated depreciation — equipment
• buildings
• accumulated depreciation — buildings
• land
• goodwill

Liabilities
• accounts payable
• sales tax payable
• federal withholding taxes payable
• FICA taxes payable
• state withholding taxes payable
• unemployment taxes payable
• accrued wages
• unearned revenue
• accrued income taxes
• note payable
Capital Accounts:
• owner's equity
• owner's drawing account
• common stock
• additional paid-in capital
• preferred stock
• retained earnings
(B) Income Statement Accounts:
Income:
• sales
• revenues
• sales returns and allowances
• sales discounts
• investment income
• gain (loss) on sale of assets

Expenses:
• purchases (if you purchase inventory for resale)

• freight (if you purchase inventory for resale)
• purchases returns and allowances (if you purchase inventory for resale)
• cost of goods sold: materials
• cost of goods sold: labor
• cost of goods sold: direct expenses
• cost of goods sold: indirect expenses
• advertising
• amortization
• bad debt expense
• bank charges
• charitable contributions
• commissions expense
• contract labor
• credit card fees expense
• delivery expense
• depreciation expense
• dues and subscriptions
• entertainment
• income taxes
• insurance
• interest expense
• maintenance
• miscellaneous
• office expense
• operating supplies
• payroll taxes
• permits and licenses
• postage
• professional fees
• property taxes
• rent
• repairs
• telephone
• travel
• utilities
• vehicle expenses
• wages

(b) Income Statement or Profit & Loss Account
Also called a profit and loss statement, or a "P&L," an income statement lists all income,
expenses, and net income (or loss). The net income (or loss) is equal to income minus
expenses. The following is an example of an income statement:
Profit & Loss Account
Sales $462,452
Cost of Goods Sold
Beginning Inventory $ 27,335
Add: Purchases 235,689
Total: 263,024
Less: Ending inventory 32,090
Cost of Goods Sold 230,934
Gross Profit 231,518
Expenses
Advertising 1,850
Depreciation 13,250
Insurance 5,400
Payroll taxes 8,200
Rent 9,600
Repairs and maintenance 13,984
Utilities 17,801
Wages 98,852
Total Expenses 168,937
Net Income $ 62,581

(c) Closing Entries
Assume that the general ledger has been finalized and a balance sheet and income
statement have been prepared for the year ended December 31, 2006. We need to prepare
the four closing entries as follows:
Debit Credit
Sales 462,452
Income summary 462,452
To close the revenue account on 31/12/2006
Debit Credit
Purchases 230,934
Advertising 1,850
Depreciation 13,250
Insurance 5,400
Payroll taxes 8,200
Rent 9,600
Repairs and maintenance 13,984
Utilities 17,801
Wages 98,852
To close the expense accounts on 31/12/2006
Debit Credit
Tom Beta, capital 62,581
To transfer 12/31/2004 net income to the capital account
Debit Credit
Owner's equity or capital. 12,000
Owner's capital, drawing 12,000
To close drawing account for year ended 12/31/2006

3.16 Converting Accrual Profit to Cash Flow
If the books are maintained on the accrual method of accounting, then some adjustments
need to be made for the actual cash flow. These adjustments are necessary because
certain expenses are taken into account to determine the accrual net profit, even though
these expenses do not currently require a cash outlay. To convert the accrual profit to
cash flow profit, a balance sheet needs to be prepared both for the beginning and end of
the period under examination.
As a general rule, accrual net profit can be converted into cash profits by using the
following formula:
Net Profit
+ Depreciation
- Increases (or + Decreases) in Accounts Receivable
- Increases (or + Decreases) in Inventories
+ Increases (or - Decreases) in Accounts Payable
- Decreases (or + Increases) in Notes Payable (Bank Loans)
= Net Cash Flow
ABC Company
Comparative Balance Sheets
31/12/2005 31/12/2006
Cash $17,845 $4,375
Accounts Receivable 12,185 27,371
Inventory 6,034 9,133
Property and Equipment 83,239 83,239
Less: Accumulated Depreciation (44,826) (48,989)
Total Assets $74,477 $75,129
Accounts Payable $6,977 $7,630
Notes Payable (Bank Loans) 27,500 12,000
Total Liabilities $34,477 $19,630
Stockholder's Equity $40,000 $55,499
Total Liabilities and Equity $74,477 $75,129

3.17 Projected Cash Outflows
The following items are generally included in the projection of cash outflows:
Anticipated Cash Outflows
• Cost of goods sold

o inventory purchases
o shipping and handling
o manufacturing costs
• Operating expenses
o payroll
o payroll taxes
o advertising
o subscriptions and dues
o professional fees
o office and postage
o rent
o utilities
o insurance
o taxes and licenses
o supplies
o repairs and maintenance
o credit card fees
o bank service charges
o other operating expenses
• One-time purchases
o new property or equipment
• Debt payments
o interest
o principal
• Other cash outflows
In accrual accounting, in addition to these items we need to forecast provisions for

liabilities, charges and contingencies. Major provisions include those for pensions,
provident funds, health and other social insurance funds, depreciation funds, capital
charges, national calamity funds, contingent liability funds, market price stabilization
funds etc.

4. Status of Accrual Accounting and Budgeting in OECD Countries
Table-2 reviews the status of accrual accounting and budgeting in OECD member
countries. It reveals that most OECD members have introduced aspects of accrual
accounting and more intend to do so in future.
Table-2 Status of Accrual Accounting and Budgeting in OECD Countries


4.1 Status of Accrual Accounting in Five pioneer countries

viz. New Zealand, Australia, the United Kingdom, the United States, and Sweden
Five countries viz. New Zealand, Australia, the United Kingdom, the United States, and
Sweden have been pioneers in accrual accounting and accrual budgeting. They provide
good examples for other countries who desire to introduce accrual accounting and
budgeting, although their systems, techniques and methodology differ significantly.
Among the countries which are moving from cash accounting and budgeting to accrual
accounting and budgeting, only Australia and New Zealand have adopted the technique
of output costing and output budgeting, and the other countries are adopting the technique
of input costing and input budgeting (Martin Dees and Paul Neelissen 2004).
Five Pioneering Countries Compared
With respect to the general design of the accrual system, the following observations can
be made about the five countries whose practices were compared by Martin Dees and
Paul Neelissen (2004).
• Most introduced an accrual system that was both comprehensive (for all central
government entities) and full (including complete statements of financial position
and financial performance and a link between these two main documents).
• Most adopted an accrual basis for both budgeting and accounting.
• The budgets and, in particular, the accounts of most include the three main
accrual-based financial statements (statement of financial position, statement of
financial performance, and cash flow statement).
• The financial statements of the various parts of central government are generally
consolidated into central government financial statements; the public sector as a
whole is generally not consolidated.
• The legislature authorizes various items: costs, cash expenditures, obligations, or

both; in most cases it principally authorizes costs.
• Accounting standards in most pioneering countries are based on private sector

standards, with certain departures to allow for the unique characteristics of their
government.
• National and government accounting are separate; national accounting standards

played virtually no role in the development of government accounting standards
in most pioneering countries.

The details of these observations are presented in Table-1 in the Box below. With
respect to the main accounting principles applicable in each country, the following
observations can be made:
• There are considerable differences in valuation policies from primarily historical

cost (Sweden, United States) to primarily modified historical cost (New Zealand,
United Kingdom) to primarily current value (Australia).
• The main statement of financial position classification agrees with the generally
accepted classification of fixed and current assets, liabilities, and equity as a
balancing item.
• Provisions for liabilities, charges and contingencies are permitted in all five
countries.
• All five countries calculate equity (under a variety of names) in accordance with
generally accepted principles as the balance of assets and liabilities.
• In all five countries, tax revenue allocated by the central tax collecting agency is
accounted for by the other parts of central government receiving the revenue.
• All five countries calculate an operating result (in a variety of ways) as the
balance between income and expenses.
• Three of the five countries apply a capital charge.
Table 2 presents the main accounting principles applicable in each country.
Anther study on “Accrual Accounting and Budgeting- Key Issues and Recent
Developments” prepared by the OECD Public Management Committee, Public
Management Service for the Twenty-third Annual Meeting of OECD Senior Budget
Officials at Washington D.C., 3-4 June 2002, concluded the following:
“About half of all Member countries have adopted accruals to one degree or another.
There are great variations, however, to what extent Member countries have adopted
accruals, from doing so for agency and ministry-level financial reporting exclusively to
whole-of-government financial reporting to budgeting (see Appendices I to IV). The
migration to accruals has been remarkably quick if one considers that it is only about ten
years since the first Member country adopted full accruals.”


“Although accruals have been used in the private sector for a very long time, it is not
possible to simply adopt private sector accruals to the public sector in bulk. There are a
number of unique issues that arise when governments move to accruals. The government
has certain types of assets and liabilities that do not exist in the private sector, including
heritage assets, military assets, infrastructure assets and the treatment of social
insurance programs. What valuation methods are used is very important, especially from
an economic analysis point of view. What institutional structures are in place for setting
accounting standards are very important, especially the need to maintain their
independence while respecting the constitutional responsibilities of the finance minister.
Finally, a great number of implementation issues arise when accruals is being adopted in
the public sector.”
“Finally, it must be emphasised that accruals is not a “magic bullet” for improving the
performance of the public sector. It is simply a tool for getting better information about
the true cost of government. It needs to be used effectively and in tandem with a number
of other management reforms in order to achieve the desired improvement in decision-
making in government.”
The purpose of this rather long quotation is to convey the message that even developed
countries with highly trained and skilled manpower and sufficient financial resources and
technology have not fully implemented accrual budgeting system, and they are still in the
process of experimentation and development.
General lessons from these experiences indicate that a shift to a full fledged accrual
system of accounting and budgeting will take longer period and cannot be done at one
stroke. However, a beginning needs to be done “for getting better information about the
true cost of government”. Initially, we need a mixture of cash and accrual budgeting i.e.
cash plus accrual accounting and budgeting.
5 Pros and Cons of Accrual Accounting
5.1 Benefits of Accrual Accounting
Proponents of accrual accounting argue that there are immense benefits of the accrual
accounting for the government, departments, the economy and Parliament such as:
(i) For the government, it is a beneficial tool for planning and control of public
expenditure and it serves as a better indicator for the fiscal sustainability and
government accountability.
(ii) At the organization level, accrual-based financial statements reduce the scope
for fraud and corruption. It also helps to judge the effectiveness of the
organization over a period.
(iii) For departments, accrual accounting system offers improved management
information, particularly on costs and assets, including working capital, thus
facilitating more informed management decisions on allocation of resources.
(iv) As the system provides a stronger basis for executive accountability,
Parliament has better control over fiscal management.
More comprehensive: IMF considers accrual accounting to be superior to cash

accounting “because accrual accounting records all resource flows, including internal
transactions, in-kind transactions and other economic flows. This comprehensive
recording permits the integration of flows with changes in the balance sheet.” Accrual
reports also provide a cash flow statement and record acquisitions of non-financial assets
separately. Conversely, cash-based accounts normally do not differentiate between
expenses and acquisitions of nonfinancial assets (such as lands and buildings).
Simpler and easier to understand: Cash accounts generally comprise a single income and
expenditure statement—in contrast to the multiple statements and accounting notes
provided by accrual information. In practice, cash-based government financial statements
tend to be difficult for understanding and interpretation. Conversely, accrual financial
statements are familiar to businesspeople, financial journalists and credit rating agencies).
Lower borrowing costs: There is evidence from the US that “states that use accrual
information borrow at better terms than those states that use solely cash information.”

Harder to manipulate: Both cash and accrual information can be manipulated, but many
technical people believe that cash accounts can be easily manipulated than accrual
accounts. Cash accounting can be manipulated by (i) selecting favorable accounting
policies; (ii) changing payment and receipt dates; (iii) changing the reporting entity; and
(iv) classifying current items as capital items or vice versa (for instance, privatization
proceeds might be shown as revenue). Accrual accounting can also be manipulated by (i)
selecting favorable accounting policies; (ii) making favorable assumptions, for instance
on discount rates; and (iii) managing accruals. However, under standard accounting
norms and guidelines and international best practices, it is more difficult to manipulate
accrual accounting than the cash accounting.
More comparable and consistent: The IMF considers that accrual accounting provides
better information about the underlying fiscal trends by removing year-to-year variability
caused by the timing of cash receipts and payments (particularly capital payments). The
revised IMF GFS and the major macroeconomic statistical systems such as UN Standard
National Accounts (SNA), IMF balance of payments (BOP), and IMF monetary and
financial statistics (MFS) use the accrual basis. Therefore, preparing government
financial statements on the accrual basis improves the accuracy and consistency of
national accounts and IMF BOP and MFS.
Includes liability disclosures: Governments generally have significant liabilities other

than public debt. An important example is the future obligation to pay civil service
pensions and other terminal benefits to the employees. Other liabilities include amounts
payable, accrued interest, accrued salaries and wages, transfer payments payable, and
environmental liabilities. These obligations are typically under-funded in the cash
account. But, accrual accounting shows the unfunded liability on the balance sheet as a
liability, and provides additional disclosures and supplementary notes on contingent
liabilities and other commitments.
Information is provided for considering intergenerational fairness. Intergenerational

fairness is important in fiscal policy—it reflects the degree to which the government
today is paying for the costs of scarce resources.
Basis for identifying payment arrears. Payment arrears arise when an obligatory payment
is not made by its due-for-payment date. All arrears are automatically included in
accrual-based statistics.
Information for managing liquidity. Managing liquidity is an important task of the

government with the help of the monetary authority. It is difficult to assess solvency and
future cash flows with the cash basis because of missing information on arrears.
Better information for decision making. Fiscal strategy deals with the management of
revenue and expenditure flows, assets and liabilities. Under the cash basis, fiscal strategy
focuses on short-term revenues and expenditures (i.e., 1–3years). Under the accrual basis,
assets and liabilities are given the same attention as debt in terms of targets, risk analysis
and contribution to economic policy objectives.
Better accountability basis. Accrual accounting is intended to provide information to

owners and lenders for better accountability and decision making. Financial reports
prepared on an accrual basis allow users to assess accountability for all resources the
entity controls and how those resources are used.
Provides information for managing resources. Cash accounts exclude most assets and
liabilities, but accrual accounting maintain complete records of assets and liabilities
leading to better asset management and maintenance, more appropriate replacement
policies, identification and disposal of surplus assets, and better management of risks
(such as loss due to theft or damage).
Identifies payment arrears. In contrast to cash information, accrual information provides

a basis for identifying payment arrears.
Supports better liquidity management. Rich information provided under the accrual basis,
including cash information, represents a sound foundation for managing liquidity.
Provides a basis for pricing products and services. Although non-financial measures are
necessary to measure quality, accrual accounting provides information on which to
compare price. By contrast, cash accounting is inadequate for pricing because some
elements of resource usage (e.g., depreciation) are not fully allocated to costs.
Reduces opportunities for fraud and corruption. The integrated asset management nature
of accrual accounting provides greatly enhanced asset stewardship. For instance, it
improves control over donor-provided assets. Furthermore, cash-based systems are more
easily manipulated than accrual-based systems.
5.2 Critique of Accrual Accounting
On the other hand, opponents argue that:
(i) Accrual accounts are very complex and more difficult to understand and are
not easily comprehensible to non-technical persons.
(ii) Implementation and operations of accrual accounting are expensive.
(iii) Measurement of assets and liabilities on the basis of accrual accounting
involves more subjectivity than that for cash accounting, and therefore may be
susceptible to manipulation.
(iv) The technical complications and time-consuming nature of the movement to
accrual accounting can be judged from the fact that only a few countries have
implemented full accrual accounting. Even among the OECD countries, the
emphasis has been to modify the pure cash-based accounting system to the so-
called hybrid accounting/ modified accrual system/ cash-plus accrual system.
(v) Therefore, at the initial stage the emphasis of the developing countries should
be on getting the basics right.

Implementation is difficult and expensive
Some aspects of accrual accounting are more difficult than cash implementations. For
example, it is difficult for a government organization to know the full amount of tax
revenue that it is likely to receive at a given time. Moreover, implementing and operating
an accrual accounting system can be expensive. However, millions of organizations use
accrual accounting, and few use cash accounting. Variations in cash accounting methods
between countries further limit the availability of computerized accounting information
systems. Indeed, many countries develop their own computer systems to support cash
accounting, rather than rely on proven commercial accounting systems (with accrual
accounting capability). In any case, whether a government uses cash or accrual
accounting, qualified accounting personnel must manage the system. Arguments are
made that non-accountant staff can operate cash-based accounting systems with minimal
input from qualified accountants, whereas accrual-based systems require trained
accountants, particularly during implementation.
Given that the private sector uses accrual accounting, recruitment and training of
accounting staff is easier under accrual accounting. Moreover, accrual systems
(generally) require fewer personnel to operate them.
5.3 Concluding Observations
Reality lies somewhere in between these two extreme views. Experiences of developed
countries provide valuable lessons for the importance of communications, quality
assurance, and the use of commercially-available accounting software.
A study by ADB5 observes that the successful implementation of accrual accounting in a

developing country depends on (a) strong political commitment; (ii) careful planning of
the phase-out and timing; (iii) clear communications of intentions and objectives; (iv)
qualified accounting and auditing personnel; (v) appropriate financial management
information systems; and (vi) the recognition of accrual accounting as a part of wider
public sector reforms.
The study concludes that developing countries adopting accrual accounting and
budgeting should do so in a realistic and practical manner, as given by the constraints of
resources and capacity. It recommends a gradual, cautious and step-by-step approach,
starting with implementation of the best practices of cash accounting systems, and
strengthening their general accounting and auditing systems consistent with the eventual
adoption of accrual accounting.
5
Lakshman Athukorala, S. and Barry Reid (2003) Accrual Budgeting and Accounting
in Government and its Relevance for Developing Member Countries, Asian Development
Bank, Manila

Selected References
Dees, Martin and Paul Neelissen (2004) Five Countries Pioneering Accrual Budgeting
and Accounting in Central Government, International Journal of Auditing, January 2004
Diamond, Jack (2002) Performance Budgeting: Is Accrual Accounting Required?

Working Paper WP/02/240. Washington, DC: IMF.
International Federation of Accountants IFAC (1996) Perspectives on Accrual

Accounting. Occasional Paper 3. New York: Public Sector Committee.
International Monetary Fund (IMF) (2002) Government Finance Statistics 2001

Companion Material. Washington, DC.
_______ (2005) Balance of Payments Manual, Washington, DC.
_______ (2007a) Monetary and Financial Statistics Manual (MFSM), Washington, DC.
_______ (2007b) Monetary and Financial Statistics (MFS): Compilation Guide,

Washington, DC.
Lakshman Athukorala, S. and Barry Reid (2003) Accrual Budgeting and Accounting
in Government and its Relevance for Developing Member Countries, Asian Development
Bank, Manila
OECD Public Management Committee (2002) Accrual Accounting and Budgeting:

Key Issues and Recent Developments, prepared for the Twenty-third Annual Meeting of
OECD Senior Budget Officials at Washington D.C., 3-4 June 2002, published by the
PUMA/SBO (2002)10, Paris.
United States of America, Government Audit Office (2000) Accrual Budgeting –

Experiences of Other Nations and Applications for the United States, Report to the
Honourable Benjamin L. Cardin, House of Representatives.
World Bank (1998) Public Expenditure Management Handbook, Washington, D.C.

Glossary
Accounting equation: Assets = liabilities + owner's equity. The financial statement

called the balance sheet is based on the "accounting equation." In general, assets are
recorded on the left-hand side of the equation, and liabilities and equities are recorded on
the right-hand side of the equation. Similarly, some balance sheets are presented so that
assets are on the left, liabilities and owner's equity is on the right.
Accounts payable: Also called A/P, accounts payable are the bills that the business
enterprise owes to the suppliers.
Accounts receivable: Also called A/R, accounts receivable are the amounts owed to the
enterprise by the clients or customers.
Accrual method of accounting: With the accrual method, income is recorded when the
sale occurs, not necessarily when payments are received. Similarly, an expense is
recorded when goods or services are received, even though payments for them may be
made later.
Adjusting entries: Special accounting entries that must be made when the books of
accounts are closed at the end of an accounting period. Adjusting entries are necessary to
update the accounts for items that are not recorded in the daily transactions.
Aging report: An aging report is a list of customers' accounts receivable amounts and
their due dates. It alerts an enterprise to any slow-paying customers. An aging report can
also be prepared for the accounts payable, which will help an enterprise manage its
outstanding bills.
Allowance for bad debts: Also called reserve for bad debts, it is an estimate of
uncollectable customer accounts. It is known as a "contra" account because it is listed
with the assets, but it will have a credit balance instead of a debit balance. For balance
sheet purposes, it is a reduction of accounts receivable.
Amortization. (1) The decrease in the value of an intangible nonproduced asset resulting
from a decrease in the remaining period of its service life. (2) The repayment of a portion
of the principal of a loan, bond, or other debt instrument. (3) The decrease in the discount
or premium recorded with respect to the maturity value of a debt instrument resulting
from the passage of time.
Arrear. An obligatory payment by a debtor to a creditor that is not made by its due-for-
payment date, including any grace period. See due-for-payment basis of recording.
Assets: Things of value held by the business. Assets are balance sheet accounts.
Examples of assets are cash, accounts receivable, and furniture and fixtures.
Autonomous pension fund. An employer social insurance scheme providing retirement benefits
that is a separate institutional unit. Autonomous pension funds that are organized and managed by
government units are classified as public financial corporations. See employer social insurance
scheme and retirement benefit.
Balance sheet: Also called a statement of financial position, a balance sheet is a financial
"snapshot" of your business at a given date in time. It lists assets, liabilities, and the
difference between the two, which is equity, or net worth. The balance sheet is a real-life
example of the accounting equation as it shows that assets = liabilities + owner's equity.
Cash method. Under the cash method of accounting, incomes are recorded only when
the cash is received from the customers. Similarly, an expense is recorded only when a
bank check is written or cash is paid to the vendor. Most individuals use the cash method
for their personal finances because it's simpler and less time-consuming. However, this
method can distort the income and expenses of an enterprise, if it extends credits to its
customers, if it buys on credit from the suppliers, or it keeps an inventory of the products
it sells.
Capital grant. A noncompulsory transfer from one government unit or international

organization to a second government unit or international organization in the form of
cash that the recipient is expected or required to use to acquire an asset or assets other
than inventories, an asset other than inventories and cash, the cancellation of a liability by
mutual agreement between the creditor and debtor, or the assumption by one unit of a
debt of the other unit.
Capital tax. A tax levied once or at irregular and very infrequent intervals on the values
of the assets or net worth of institutional units or on the values of assets transferred
between institutional units as a result of legacies, gifts inter vivos, or other transfers.
Capital transfer. A transfer of a non-cash asset, the cancellation of a liability by mutual

agreement between the creditor and debtor, the transfer of cash that was raised by
disposing of an asset, the transfer of cash that the recipient is expected to use for the
acquisition of an asset, or the assumption by the one unit of a debt of the other unit. In
each case inventories are excluded.
Chart of accounts: The list of account titles used to keep accounting records.
Closing: Closing the books refers to procedures that take place at the end of an
accounting period. Adjusting entries are made, and then the income and expense accounts
are "closed." The net profit that results from the closing of the income and expense
accounts is transferred to an equity account such as retained earnings.
Corporation: A legal entity, formed by the issuance of a charter from the state. A
corporation is owned by one or more stockholders.

Cost of goods sold: Cost of inventory items sold to customers. It may consist of several
cost components, such as merchandise purchase costs, freight, and manufacturing costs.
Credit memo: Writing off all or part of a customer's account balance. A credit memo is
required, for example, when a customer who bought merchandise on account returned
some merchandise, or overpaid on their account.
Credits: At least one component of every accounting transaction (journal entry) is a

credit amount. Credits increase liabilities and equity and decrease assets. For this reason,
credits are generally entered on the right-hand side (the liability and equity side of the
accounting equation) of a two-column journal or ledger.
Current assets: Assets that are in the form of cash or will generally be converted to cash
or used up within one year. Examples are accounts receivable and inventory.
Current liabilities: Liabilities payable within one year. Examples are accounts payable
and payroll taxes payable.
Debit memo: Billing a customer again. A debit memo would be required, for example,
when a customer has made a payment on their account by check, but the check bounced.
Debits: At least one component of every accounting transaction (journal entry) is a debit
amount. Debits increase assets and decrease liabilities and equity. For this reason, debits
are generally entered on the left-hand side (the asset side of the accounting equation) of a
two-column journal or ledger.
Depreciation: An annual write-off of a portion of the cost of fixed assets, such as

vehicles and equipment. Depreciation is listed among the expenses on the income
statement.
Double-entry accounting: In double-entry accounting, every transaction has two journal

entries: a debit and a credit. Debits must always equal credits. Because debits equal
credits, double-entry accounting prevents some common bookkeeping errors. Errors that
do occur are easier to find. Double-entry accounting is the basis of a true accounting
system.
Drawing account: A general ledger account used by some sole proprietorships and
partnerships to keep track of amounts drawn out of the business by an owner.
Equity: The net worth of a company. Also called owner's equity or capital. Equity comes
from investment in the business by the owners, plus accumulated net profits of the
business that have not been paid out to the owners. It essentially represents amounts
owed to the owners. Equity accounts are balance sheet accounts.

Expense accounts: These are the accounts used to keep track of the costs of doing
business: where money goes. Examples are advertising, payroll taxes, and wages.
Expenses are income statement accounts.
Fixed assets: Assets that are generally not converted to cash within one year. Examples
are equipment and vehicles.
Foot: To total the amounts in a column, such as a column in a journal or a ledger.
General ledger: A general ledger is the collection of all balance sheet, income, and
expense accounts used to keep the accounting records of a business.
Income accounts: These are the accounts used to keep track of sources of income.
Examples are merchandise sales, consulting revenue, and interest income.
Income statement: Also called a profit and loss statement or a "P&L." It lists income,
expenses, and net profit (or loss). The net profit (or loss) equals income minus expenses.
Inventory: Goods held for sales to customers. Inventory can be merchandise bought for
resale, or it can be merchandise manufactured or processed for selling the end product to
the customer.
Journal: The chronological, day-to-day transactions of a business are recorded in sales,

cash receipts, and cash disbursements journals. A general journal is used to enter period
end adjusting and closing entries and other special transactions not entered in the other
journals. In a traditional, manual accounting system, each of these journals is a collection
of multi-column spreadsheets usually contained in a hardcover binder.
Liabilities: What your business owes creditors. Liabilities are balance sheet accounts.
Examples are accounts payable, payroll taxes payable, and loans payable.
Long-term liabilities: Liabilities that are not due within one year. An example would be
a mortgage payable.
Merchandise inventory: Goods held for sale to customers.
Net income: Also called profit or net profit, it is equal to income minus expenses. Net
income is the bottom line of the income statement (also called the profit and loss
statement).
Partnership: An unincorporated business with two or more owners.
Post: To summarize all journal entries and transfer them to the general ledger accounts.
This is done at the end of an accounting period.

Prepaid expenses: Amounts paid in advance to a vendor or creditor for goods or

services. A prepaid expense is actually an asset of an enterprise because the vendor or
supplier owes the goods or services to the enterprise. An example is the unexpired
portion of an annual insurance premium.
Prepaid income: Also called unearned revenue, it represents money received in advance
for providing a service to the customer. Prepaid income is actually a liability of the
enterprise because it still owes the service to the customer. An example is an advance
payment to a Consultant for some consulting services to be performed in the future.
Profit and loss statement: Also called an income statement or "P&L." It lists all income,
expenses, and net profit (or loss). The net profit (or loss) equals income minus expenses.
Proprietorship: An unincorporated business with only one owner.
Reserve for bad debts: Also called allowance for bad debts, it is an estimate of
uncollectable customer accounts. It is known as a "contra" account because it is listed
with the assets, but it will have a credit balance instead of a debit balance. For balance
sheet purposes, it is a reduction of accounts receivable.
Retained earnings: Profits of the business that have not been paid to the owners; profits
that have been "retained" in the business. Retained earnings are an "equity" account that
is presented on the balance sheet and on the statement of changes in owners' equity.
Sole proprietorship: An unincorporated business with only one owner.
Trial balance: A trial balance is prepared at the end of an accounting period by adding
up all the account balances in the general ledger. The debit balances should equal the
credit balances.
Unearned revenue: Also called prepaid income, it represents money received in advance
of providing a service to the customer. It is actually a liability of an enterprise as it still
owes the service to the customer. An example is an advance payment to a Consultant for
some consulting services to be performed in the future.
Work-in-progress inventories. Goods and services that have been partially processed,
fabricated, or assembled by the producer but that are not usually sold, shipped, or turned
over to others without further processing and whose production will be continued in a
subsequent period.
Written-down replacement cost. The initial acquisition cost of an asset plus an

appropriate revaluation for subsequent price changes, minus an allowance for
consumption of fixed capital, amortization, or depletion.

APPENDIX I
Accounting Basis Applied for Budget Approved by Legislature
Accrual Basis, except Cash Basis, except

Full Full
Country no Capitalization or certain
Accrual Cash
Depreciation of transactions on
Basis Basis
Assets Accrual Basis
Australia X
Austria X
Belgium X
Canada X
Czech Rep X
Denmark X(1)
Finland X(2)
France X
Germany X
Greece X
Hungary X
Iceland X
Ireland X
Japan X
Korea X
Luxembourg X
Mexico X
Netherlands X
Norway X
New Zealand X
Poland X
Portugal X
Spain X
Sweden X
Switzerland X
Turkey X
United
X(3)
Kingdom
United States X(4)
i. Denmark – Interest Expenses and Employee Pensions Treated on

Accrual Basis.
ii. Finland – Transfer Payments Not on Accrual Basis.
iii. United Kingdom – Budget on Full Accrual Basis Effective Fiscal
Year 2001-02.
iv. United States – Interest Expenses, Certain Employee Pension
Plans, and Loan and Guarantee Programmes Treated on Accrual Basis.
Source: OECD Budgeting Database

APPENDIX II
Plans to Move Budget to Accrual Basis
Country Full Accrual Basis Budgeting Additional Accrual Basis

to be introduced information to be presented
Canada X(1)
Denmark X
Germany X
Korea X(1)
Netherlands X
Portugal X
Sweden X(1)
Switzerland X(1)
i. under Active Consideration.

APPENDIX III
Additional Use of Accruals in Departmental / Agency Level
Financial Statements
Country
Departmental/ Agency Financial Statements on Full Cash Basis
Level Financial Statements but Supplementary Accrual Information is
on Full Accrual Basis presented
Belgium X
Germany X
Hungary X
Ireland X
Japan X
Netherlands X
Portugal X
Switzerland X
United
X
Kingdom
i. This refers to departments/agencies that prepare separate

financial statements for their own operations and where such financial
statements contain more accrual information than the consolidated (whole-of-
government) financial statements. In cases where the consolidated (whole-of-
government) financial statements are on full accrual basis (Appendix 3),
departmental/agency level financial statements would also be on full accrual
basis.


APPENDIX IV
Accounting Basis Applied for Consolidated (Whole-of-Government)
Financial Statements
Full Accrual Basis, except no Cash Basis, except Full Cash

Accrual Capitalization or certain Transactions Basis
on
Basis Depreciation of Assets Accrual Basis
Australia X
Austria X
Belgium X
Canada X
Czech Republic X
Denmark X(1)
Finland X
France X(2)
Germany X
Hungary X
Iceland X
Ireland X
Japan X
Korea X
Luxembourg X
Mexico X
Netherlands X
Norway X
New Zealand X
Poland X(3)
Portugal X
Spain X
Sweden X
Switzerland X
Turkey X
United
X(4)
Kingdom
United States X
i. Denmark – Interest Expense and Employee Pensions Treated on Accrual Basis.

ii. France – Interest Expense and Certain Other Transactions Treated on Accrual Basis.
Full Accrual Basis to be introduced.
iii. Poland – Employee Pensions Treated on Accrual Basis.
iv. United Kingdom – Statements on Full Accrual Basis Effective Fiscal Year 2005-06.
Source: OECD Budgeting Database.

Accrual Accounting and Accrual Budgeting

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Accrual Budgeting – Tarun Das

Accrual Accounting and Accrual Budgeting-

Prof. Tarun Das1, Ph.D.

Glocoms Inc. (USA) 1 MOF, Govt. of Mongolia

1.1 Cash and Accrual Accounting

2 Government Accounting Systems

3 An Operational Cash Plus Accrual Accounting System

4 Status of Accrual Accounting in OECD Countries

5 Pros and Cons of Accrual Accounting

Glocoms Inc. (USA) 2 MOF, Govt. of Mongolia

1. Cash and Accrual Accounting

Cash Method Accounting

Accrual Method Accounting

Glocoms Inc. (USA) 3 MOF, Govt. of Mongolia

Table-1: Differences between Cash and Accrual Systems

2. Only a cash flow statement is prepared 2. Under accrual accounting2—in addition to

2.1 Operating Statement: Shows the

Hybrid method or Cash plus Accrual method

1.2 Accrual Accounting in Developing Countries

Glocoms Inc. (USA) 4 MOF, Govt. of Mongolia

1.3 Accrual Accounting and Economic Statistical Systems

Government accounting systems determine how financial and statistical information is

Glocoms Inc. (USA) 5 MOF, Govt. of Mongolia

(4) The International Federation of Accountants (IFAC) introduced International

These international systems have slightly different purposes. Figure-2 illustrates

Accrual Budgeting and Its Relevance for Developing Countries

System of National Accounts

Most recently revised in 1993, SNA comprises an integrated set of macroeconomic

Glocoms Inc. (USA) 6 MOF, Govt. of Mongolia

Government Finance Statistics

International Public Sector Accounting Standards

2. Government Accounting Systems

However, there were no such pressures on the government as it is not guided by

2.1 A Simple example of Accrual Accounting

Glocoms Inc. (USA) 7 MOF, Govt. of Mongolia

Table-2 Accrual Accounting

Cash flow statement Operating statement Balance Sheet

Total 770 40 810

Total 130 Total 500 70 570

Bank balance Equity and reserves 270 30 240

Glocoms Inc. (USA) 8 MOF, Govt. of Mongolia

3. An Operational Cash Plus Accrual Accounting System

Single- or Double-Entry Accounting

3.1 Accruing Wages Payable

Debit (MNT) Credit (MNT)

3.2 Accruing Pension and Health insurance contributions

3.3 Adjusting Interest and Loan Balances

3.4 Prepaid Insurance

Suppose a department paid an annual staff car insurance premium of 12 MNT on

Glocoms Inc. (USA) 10 MOF, Govt. of Mongolia

eight months of prepaid coverage (8 MNT) represents an asset to the department. We

3.5 Adjusting Entry for Inventory

3.6 Accruing Interest Income Receivable

Glocoms Inc. (USA) 11 MOF, Govt. of Mongolia

3.7 Recording Depreciation Expense

3.8 Adjusting for Bad Debts or Contingent Liabilities

3.9 Accruing Dividends Payable

Debit (MNT) Credit (MNT)

Glocoms Inc. (USA) 12 MOF, Govt. of Mongolia

3.10 Accruing Zero Coupon Bonds

3.11 Accruing Income Taxes Payable

Debit (MNT) Credit (MNT)

Glocoms Inc. (USA) 13 MOF, Govt. of Mongolia