Audit Assistant at RSM Poland
The problem of settling costs in time is that not every cost may be recognised in the ledgers on a one-off basis. The differences between such terms as: cost, expenditure or expense may cause additional trouble.
Every now and then, in business practice, we deal with some expenditures (acquisition of fixed assets, payment for insurance policy, etc.). Such expenditures become costs gradually or only once. Some expenditures relate to more than one reporting period. In such case, they should be settled for all the periods that they relate to. Including these costs in the period in which they were actually incurred would corrupt the financial result of the company.
These costs should be settled in time proportionately to the months they relate to, e.g. costs of property insurance paid in advance for the entire year should be activated and then entered as costs, on a pro rata basis in each month that the insurance period applies to.
Principles of cost settlement in time
Cost settlement in time is subject to the following accounting principles:
- accrual basis – all the financial operations for a particular period should be recognised in the ledgers for the period they refer to. This means that you cannot recognise deferred income and costs in a given period;
- matching principle – all income and corresponding costs (related to obtaining this income) should be recognised in the accounting ledgers;
- prudence principle – income and costs shall be recognised on a prudent basis, i.e. they shall be neither underrated nor overrated;
- materiality principle – not all costs related to other reporting periods shall be settled in time. If the recognition of costs in the period in which they were incurred has no material impact on the financial result, such costs may be recognised in a given reporting period. This means that it is not necessary to settle in time immaterial amounts.
Prepayments and accruals
Cost settlement in time is governed by the Accounting Act (hereinafter AA). Pursuant to Art. 39 of the AA, cost settlement in time shall be effected through prepayments and accruals.
Deferred costs are settled by prepayments, while probable current period liabilities are settled by accruals. According to the Act, such liabilities include, inter alia, liabilities related to the services performed by contracting parties, which amount can be determined (e.g. provision for audit) and liabilities arising from the obligation of future employee benefits related to current operations (provisions for unused leave). However, it should be noted that in the balance sheet, some of these costs will be presented as provisions, pursuant to Art. 39 of the AA (e.g. provisions for employee benefits, whose value and execution time estimated in a reliable manner are not certain).
Cost accounting – records and settlement of costs in time
Cost settlement in time is recorded on the accounts of prepayments and accruals. Deferred costs are posted on the debit side in the prepayments account. And the costs of the current period recognised in accruals are recorded on the credit side in the accruals account.
In the event when an entity applies cost accounts of both systems (comparative and calculation), accruals and prepayments are recorded through the account "Settlement of costs by type". In such case, costs are initially recognised in the accounts of costs by type and then, through the account of the settlement of costs by type they are reclassified to prepayments and accruals.
Examples of costs settled by prepayments:
- property insurance paid in advance,
- rents paid in advance,
- magazine subscriptions paid in advance,
- taxes paid in advance, e.g. property tax,
- annual contribution to the Company Social Benefits Fund,
- costs of major renovation of fixed assets.
Examples of costs settled by accruals:
- costs of future retirement benefits,
- costs of unused leaves,
- costs of service anniversary awards,
- costs of warranty repairs,
- costs of invoices not received yet for electricity, gas,
- costs of the performance of services that have not been completed yet, e.g. construction services.
Decision on which costs will be recognised in the balance sheet as accruals and which will be presented as provisions depends on the reliability of the estimates – whether it is a clearly defined amount, and the completion time limit (e.g. cash outflow) is certain ... but you will find more information in this respect on our blog soon.
 Cf. International Financial Reporting Standards – International Accounting Standard 37, par. 11, London, 2016