Jedi Accrual Accounting

Use the Force

by Bernie Mapili, CPA, MST / Published Sept 2015

“A long time ago in an accounting galaxy close, close to you. . .” thousands upon thousands of bookkeepers have complained that accrual accounting is much too difficult, as if it’s the Darth Vader of the accounting world bent on making sure you never have hope of high quality accounting. Well, if you agree, I am here to convince you it is not darkness but actually light! A new hope awaits and more blatant Star Wars Easter Eggs. Let’s nerd on folks! 

In the mighty words of Yoda, “No! Try Not! Do or do not. There is no try.”  The green, little dude is not only a Jedi Master but also has an accounting degree. True story, believe me! At the end of the day even if you “try” to do your books only under cash accounting, you are either undoing accrual accounting to force your world to be, or you are performing accrual accounting outside of the books to operate your community. Here is a quick example of each.

 For the first example of forcing cash accounting upon the persistent accrual system is billings in the owners’ accounts. To keep it simple, some folks take the time to manually delete what you’ve billed homeowners that haven’t paid their regular dues so that accounts receivable does not exist on the books. In cash accounting, accounts receivable should never exist even if you will collect on it within the next 10 days. Does that make sense? It shouldn’t. It’s quite aggressive to force your books into cash basis especially if the electronic accounting system you use automates it such as a billing module. I promise you we actually have clients who do this, thinking it’s easier than accrual accounting. Imagine three years or longer of homeowners’ ledgers “ignored” on the books.

Anyway, the opposite example of doing accrual accounting is when you plan out your cash flows. We have clients who need to pay bills beyond the cash balance in their bank account. So what do they do? They don’t immediately call vendors and utility companies and say they can’t pay them. They compare the budget to actual and estimate how much will realistically be collected. That’s not only a smart thing to do, that’s actually accrual accounting! It’s technically called the Matching Principle, where you are taking the time to figure out what you have a right to collect and your timing of collection in relation to an expense near that time frame. 

Therefore, we’ve established accrual accounting always exists as in the Force. At the end of the day, a bookkeeper chooses the path of a Jedi Accrual Accountant or a Dark Sith Lord of Cash Accounting. So is accrual accounting truly that hard to master? Well, at a high level, there is one clear objective. Keep your books sharp at the end of each month and at a bare minimum on the last day of each fiscal year such as December 31, 2015. The month end close is where the conflict exists, and there are four parts to accrual accounting. Mastering these four parts makes you an official new Jedi Accrual Accountant! The four parts are Accounts Receivable, Deferred Assessments, Accounts Payable, and Accrued Expenses.

To lay the groundwork, here are the recurring assumptions to help as we tour the four parts together. The Simple Homeowners  Association, Inc. (Simple HOA) has 10 units paying $1 per month, which is a total of $12 per month and $144 per year. Let’s apply this to the first of four to tackle, which is Accounts Receivable (AR). If you use any form of true accounting system including QuickBooks, it automates the maximum value of AR for you. What does it do? Well, each month when you bill the homeowners, the accounting system would show a revenue of $12. That’s the easy part. The accrual part is using your bad debt analysis to increase bad debt allowance by the amount you know you will not collect. For Simple HOA, we have 1 of the 10 units that is in bankruptcy and never pays. So at month end, you book a journal entry to increase bad debt allowance and bad debt expense by $1. You know you won’t collect it, so at the highest level possible you “write it off.”  One key caveat is that you are doing this at the highest level possible, which is at the general ledger level and not at the homeowner ledger level. Your collections department via a lawyer dictates when a debt is truly, forever uncollectible, and it is at that time that you write it off that homeowner’s account permanently.

The next step in Jedi Accrual Accounting is Deferred Assessments. In Simple HOA, we have one homeowner who pays the full annual assessment of $12 on January 1. So before you close the books on January 31, you need to book a journal entry to move $11 out of revenue and move it to a liability as a deferred assessments. Then each month forward you move $1 out of the liability account and into revenue. Why you ask? Simple HOA has not earned the full year of revenue until the first of each month. If that homeowner requested their money back, you legally have to return the advanced portion! It’s a critical failure of cash accounting as this method would say you can spend it. Regardless of your basis of accounting, Simple HOA does not own that prepaid money,  and it is your fiduciary duty to track homeowner ledgers accurately. 

Bernie Mapoli, CPA, MST, Partner

Mapili CPA, LLC

Mapili CPAs is located in Winter Park servicing all of Central Florida. Their audit practice is niched in the community association industry focusing on the CPA needs of HOAs, condominiums, and other related entities. Most community associations need a Certified Public Accountant (CPA) to perform the required compilations, reviews, and audits. Bernie Mapili has been a Certified Public Accountant since 2004. He holds a Masters of Taxation from the University of Central Florida. For more information, call (855) CPA-1040 or visit www.MapiliCPAs.com.

The third step is Accounts Payable (AP). Again, your accounting system automates this for you as when you cut a check to pay a bill, it automatically creates an open liability for the unissued check and hits the expense for the service or product provided. When the check is issued out, it reverses out of AP and reduces your cash balance. At month end, you need to reconcile the activity and make sure all outstanding checks are reasonable. As my Padawan daughter would say “easy peasy lemon squeezy.”

The last step is Accrued Expenses. At month end, all you have to do here is review your monthly expenses and see what’s missing. It could be a regular monthly vendor, a contracted service, or a service or product you know you have received but have yet to receive a bill. Before you close the books for the month, you book a journal entry debiting the expense and crediting Accrued Expenses. This should be an entry that reverses out the following month. Feel free to use an estimate of an expense if you know the ballpark of the expense or at least have an e-mail from the party billing you. 

At the end of the day, it takes these four steps once a month to perform basic Jedi accrual accounting. It truly is not that hard but requires focus and regular action. I highly recommend creating a checklist that includes each specific action step required to close the books at month end. You sign off as you complete each task in order and you won’t succumb to the darkness.