All broker dealers must maintain their financial information on an accrual accounting basis. The question is what is accrual accounting? Generally Accepted Accounting Principles (GAAP) defines accrual accounting as matching revenues with expenses for a particular period. However, this theory known as the matching concept sometimes causes an item in the balance sheet not to meet the definition of a liability. A liability is defined as a present obligation of the company from a past or current event.
Some examples are listed below:
- A company receives its electric bill for January in the month of February. Is the amount an obligation at the end of January? The amount is an expense and a liability at the end of January despite the fact that it only becomes payable when the bill is received.
- A company accrues vacation pay each pay period per the employee’s allowed vacation. (ie: 2 weeks vacation per year) Should the firm accrue a liability for the vacation pay earned each pay period? Yes, the amount will be accrued each pay period although the amount is not payable until the employee takes vacation.
- A company’s auditors only start work on the annual audit in February for a December year end. As no audit work has been done by the year end, there is no liability to pay any amount at the end of the year, so there is no present obligation at this date. Many people have said that since the audit is required by law it must be accrued.
The audit scenario is a good example of the income statement vs. the balance sheet approach. In a recent accounting seminar that we attended a partner from a big three accounting firm and a director of the AICPA said that his firm always accrued it at year end. He went on to tell the audience that to his surprise his firm had dug up an old AICPA interpretation that said it should be accrued only after the service is performed. However, he recommended being consistent and treating this in the same manner the firm had in the past but he strongly was against accruing for the audit by recording one twelfth of the cost each month.
Some additional situations where an evaluation on whether or not to accrue may be needed include: bonuses (Discretionary or not), lawsuits, contingent liabilities, taxes and deferred revenue. The accounting boards are expected to move to a full balance sheet approach sometime after 2010. Until this discrepancy is resolved the best approach is to be consistent with a conservative attitude.
If you have questions about an accounting matter including when an accrual is required, Regulatory Compliance’s accounting staff is available to assist you. They can be reached by calling 1-603-434-3594 ext. 123 for Danielle and ext. 116 for Addie or by email at accounting@regulatorycompliance.com.
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