Accrual-Based Accounting

OVERVIEW 

There are two basic methods of accounting:  Cash and Accrual. The main difference between the two is the timing of when revenue and expenses are recognized.  Cash accounting recognizes revenue and expenses when cash exchanges hands - when incoming payments are received and when outgoing payments are made.  Accrual accounting recognizes revenue and expenses when incurred – when the service is delivered to the client with the expectation that money will be received in the future and when expenses are recorded despite there being no cash being paid out for those expenses.  Although cash accounting is “easier”, accrual accounting portrays a more accurate picture of a company’s health by including accounts payable and accounts receivable. 

When switching from cash to accrual accounting in Centerbase: 

The balance sheet will now include both accounts receivable and accounts payable accounts.  These two accounts keep track of what the firm is owed from its clients and what it owes to its vendors.  In cash accounting, these accounts are not necessary since revenue and expenses are only recorded when cash has exchanged hands.   

Contra-income accounts for discounts and credits will be added to the profit and loss statement as well to keep a record of discounts, credits and write-offs to client bills.  Again, these accounts are not necessary in cash accounting because revenue is not recorded until payment is received.  Typically, all credits would have been accounted for before the client pays its bill. 

SETUP 

All that is necessary to get started utilizing accrual accounting in Centerbase is to make a few default system settings changes.  This will need to be performed by a user with permissions to set system defaults. 

First, in Accounting/General Settings, the accounting method will need to be changed from “Use Cash” to “Use Accrual”. 

Further down in the Accounting Settings, the Default Accrual Accounts will also need to be updated.  

The accounts used for Discount Account and Credit Account will need to be set up as contra-income accounts on the chart of accounts.  These will be the system default accounts but can be overridden at the Client or Matter level, if needed. 

The default account that is currently being used for Hard Expenses Advanced should also be used as the Vendor Credit Account.  This, too, can be overridden, at the Vendor level if the expenses associated with a particular vendor are typically firm expenses instead of matter expenses. 

Centerbase allows a choice of income recognition either (1) at the time of pre-bill generation or (2) at the time of bill posting.  If income will be recognized when a pre-bill is posted, it will be necessary to adjust a default Billing System Setting.  Under Posting Invoice, the Use Pre-bills box will need to be unchecked.   

INCOME RECOGNITION 

For purposes of this demonstration, assume income will be recognized upon the posting of a client bill.  

When using accrual accounting it is very important to ensure that the issue date is correct when posting a client bill because that will be the date that the income derived from the client bill will be recognized.   

Once the client bill has been posted, income recognition can be verified by viewing the Fee Income account. The posted bill will also be added to the Accounts Receivable account on this date. 

EXPENSE RECOGNITION 

Likewise, when a vendor bill is created or a check is issued, the Issue Date will be the date the expense will be recognized.   

The newly created vendor bill (or issued check) can be found in the designated Vendor Credit Account Account (or expense account, if a firm expense), as well as in Accounts Payable. 

FINANCIAL REPORTING 

When utilizing Accrual Accounting in Centerbase, a very useful feature is the ability to quickly toggle between Cash and Accrual Accounting on financial reports temporarily. This will aid in analyzing both the current cash flow and future financial health of a firm.  The toggle can be found at the top of each report.