Companies show both accruals and provisions on their financial statements, which helps them to better manage their finances. Organizations use provisions to prepare for future contingencies by setting aside a specific amount of money. In some cases, however, the money may be insufficient for the unforeseen event.
Accruals, on the other hand, can be for either expenses or revenues, whereas provisions are always for expenses.
Accrual based accounting is a system of accounting in which an expense or a revenue is acknowledged when it occurs. The company does not wait for the exchange of cash to take place. With an accrual, the amount of the transaction, whether it is an expense or revenue, is already known beforehand -- the company just hasn't received or paid the monies yet. This form of accounting is commonplace in many business, and conforms to the provisions of the generally accepted accounting principles, or GAAP. Companies use this system to prepare their financial statements for its external stakeholders.
Types of Accruals
Accruals divide into accrued expenses and accrued revenues. Accrued expenses are all those expenses due in the future, such as labour wages at the completion of a project or interest that the company pays to shareholders at the end of every quarter. Accrued revenues is money the company will acquire at the end of a stipulated time, such as money owed to the company by clientele.
Companies make provisions to meet their future obligations, although the exact expense is unknown at the time the company makes the provisions, or whether the provision will even be necessary. By the time the contingency occurs, the company will already have sufficient funding to address the incident. This prevents any financial loss that would directly impact a business' operations.
Types of provisions
Companies have different kinds of provision accounts, such as provisions for depreciation -- the decline in value of a company's assets, like machinery, as a result of wear and tear, age or when the company no longer has a need for the asset. The company depreciates all its assets annually and sets aside the money for depreciation in this account. By the time the asset stops working, the company already collected the necessary money to replace the asset.
Provision for bad debts is another example in which a company provides loans and materials to other entities. These entities must pay back the loan after an allotted period of time. The company estimates that it will not receive all the money due to potential defaults on the loan, so it sets aside five to 10 per cent of the amount to provide for unpaid debts. Provision for income taxes is yet another type of provision.
- Jupiterimages/Photos.com/Getty Images