What are Provision and Accrual in Accounting?
Both provision and accrual are essential in financial reporting, and they help the users of a company’s financial statement to understand its financial position more clearly. Thus, the accountants who are responsible for keeping the books of accounts (Also see Why Do the Accountants Close the Books?) of the company should make sure that they have recorded and reported the amounts accurately.
By recording the amount of provisions and accruals correctly, the company’s management and shareholders will be able to understand the exact financial health of the business. As such records are so crucial, you as the business owners should ensure that these amounts have been recorded correctly. If you do not know accounting well or if you cannot afford to hire an in-house accountant, do not hesitate to hire an accounting firm in Johor Bahru. The experts can not only help you to save time and money but also ensuring that the business transactions have been recorded accurately.
Now, let us have a look at the provisions and accruals in detail.
Provision is an allowance that the company has made for any possible obligation that the company may have to bear in future. There is a high level of uncertainty for the amount that is involved in provisions, so the accountants can hardly determine the amount in advance. However, companies should make provisions ahead of time to cover the uncertainties that the company may need to face in the future.
An example of the provisions that a company should make is the provision for doubtful debts. This is the provision that the company makes on its future receivable as there is a possibility where a portion of those receivables will go bad, and the company will not be able to collect them. The company should have the ability to justify the provisions that it should make in a certain reporting period by complying with applicable frameworks.
Accrual, on the contrary, is the recognition of revenue and expense that the company has earned or incurred but has not received or paid. Accruals are related to revenue and expense. A company should list its accrued expenses in its ledger balance (Also see Components in Balance Sheet). In terms of the level of certainty, the accrued expenses will certainly be due in the future.
Some may think that provisions and accruals are similar. However, this is not true. There are some significant differences between provisions and accruals. One of the most significant ones would be the concepts which apply to them. Provisions work on the prudence concept, where based on this concept, the company should not predict that it will earn a profit (Also see What is in a Profit and Loss Statement?). Instead, it should make provisions for any possible loss that it may suffer in the future. As against, the concept that applies to accruals (Also see Differences Between the Accrual Basis and Cash Basis of Accounting) is the matching concept. This concept states that the revenue and the expense a company has reported in an accounting period should match with each other.
When making provisions, the amount involved is uncertain, and the company needs to estimate the loss that it may suffer from the debts that go bad. On the contrary, the amounts for accruals are specific, which is the amount that it will earn or incur. Some of the examples for the provisions include provisions for doubtful debts as well as depreciation provision. On the contrary, an example of the accruals is a major repair that has taken place at the end of an accounting period, but the company will only pay for it at the beginning of the next accounting period.