Every company has to make a choice between using cash and accrual method for their bookkeeping. Sometimes this choice is made for us, dependent on IRS rules, but overall there are a few pro’s and con’s to consider when making the decision.
The simplistic difference between the two is that cash method recognizes revenue when it receives payment and expenses when payment is made. Accrual accounting matches revenue and expenses regardless of when payment is made or received. Cash method gives you a more clear picture of your cash position, however, accrual shows the flow of income versus debt. Most businesses end up using both methods so that they can have a better understanding of what the numbers truly mean – knowing how healthy cash flow is, as well as understanding spend versus revenue. It’s important to note that once your business has more than $5 million per year in sales or carries more than $1 million per year in inventory, the IRS requires that you use the accrual method as your primary accounting method.
For any business, tracking expenses is non-negotiable. A large part of business expenses are tied up in employee purchases, whether a reimbursable expense or a corporate card transaction. More often than not, employee purchases are recorded on a cash basis, regardless of the accounting method used, because of restrictions put on the finance team, whether by way of time or context. Meaning that the expense is allocated to the month an expense report is submitted and payment or reimbursement is made. However, they should be recorded in the same method that you record your other business expenses in order to keep your records consistent for better reporting or in case of an audit.
This article discusses the challenges finance teams face when recording employee expenses when they use the accrual method and the best practices for overcoming those challenges.
Challenges & Best Practices
The biggest, overall challenge in recording expenses in accrual method revolves around the “expense report” – a foundational element of the traditional expense management workflow. It was originally meant as a way for employees to simplify how they reported their expenses and to lessen the number of checks written to reimburse them. However, it put additional burdens on the finance team as a consequence, most notably in how expenses are recorded and tracked. They were left facing a very manual process or to record expenses in a way more similar to cash method.
Challenge: Record Dating
Whether you use spreadsheets or software to track employee purchases made on behalf of the company, you’re most likely using an expense report in your workflow. This element of the process presents the largest challenge that finance teams face, especially those who are using the accrual method. When expenses are submitted in the form of an expense report, they are being attributed to a date that is neither the date the expenses were incurred or the date payment was made. Expense reports add in a third, and rather arbitrary date that is merely the date the employee chose to send in their receipts.
Best Practice: Each expense should be recorded against the date it was incurred or the last open month.
Challenge: Associating Payment
An expense report creates a cage around expenses that finance teams need to manually break apart in order to be able to associate expenses to the correct time period, which leads to the second issue, payment. Typically, a lump sum payment is made to the employee to cover the total amount owed according to the expense report. If the expenses are broken out of the report, reconciling the lump sum payment with the individual expense becomes more challenging because they may spread across months. While this isn’t a necessity if everything balances out, it’s a best practice to associate the payment with the expense to ensure that payment has been made.
Best Practice: Associate the payment or reimbursement with each applicable expense for future reference.
Challenge: Vendor Transparency
When expenses are kept bundled together and recorded as an expense report, not only can the dates of expenses get lost, but transparency into the vendor or merchant becomes grey as well. Merchants are listed within the line item of the expense report and the whole report is usually filed under the employee who submitted it. However, when you break out the expense line items into separate records, you can file the expenses by merchant. This will help provide transparency for budgeting and trends.
Best Practice: Each expense record should be filed against the merchant and not against the employee submitting the expense.
Challenge: Policy Compliance
Another struggle the expense report presents is that it encourages employees to hang on to their receipts, which is often a lengthy period. When using accrual, it’s important to get all expenses before the month is closed. If you know an expense is coming, you can adjust for it ahead of time, it’s the ones you don’t know are lingering that cause trouble.
Best Practice: Use incentives like faster reimbursements to encourage employees to not hang onto receipts.
The Difference with Accrual
Employee expenses are a treasure-trove of information that most businesses have yet to tap into. They can provide information on customer acquisition costs, return on investment, and insights for how to optimize spend. By tracking expenses in accrual method, you can directly relate all of your spend to your revenue to learn exactly what your sales team is spending per client or how much was spent across accounts payable and expenses for an event versus what you got back in new bookings.
Ultimately, the more detailed your record keeping is the more information you have at your disposal. However, you have to be able to properly access that information in order to make use of it. So keeping it locked up as line items of an expense report, prevent you from diving any deeper than top level. By using the accrual method, you are breaking your data out of it’s confines so that you can use it in a more meaningful way.
How to “Go Accrual”
The process for tracking employee expenses has long been taken “as-is.” The sentiment is that it is a painful process that can’t be made better and will end with either a sacrifice of data quality or time spent manually recording the data properly. More often than not, it’s the quality that is on the chopping block.
Expense reports present an outdated solution to improving the expense management workflow, which ultimately puts restrictions on keeping accurate records and reporting. But now that we know the reality, that the expense report is at the root of the problem, we can figure out a better way to solve it.
With the options available today, it is easy and cost effective to implement an expense reporting solution. However, remember that most still rely on expense reports. While evaluating solutions, make sure that the system you select can track expenses independently of expense reports and be sure to ask about syncing in accrual method.