Frequently associated with accounting
procedures relating to the recapture
provisions involving capital invested in
improvements over their remaining economic
life.
For purposes of accounting, accruals for
depreciation are sometimes referred to as
future depreciation , given that the amount
is set aside at the start of a fiscal period
for future allocation relating to a
particular item. This total is then expensed
monthly during that fiscal period. In
practice, various items falling under the
same general category (class of assets) are
normally grouped together. Canada Customs
and Revenue Agency establishes the rate of
depreciation allowed for any particular
class of assets. The government recognizes
that capital assets, though durable, do have
a limited lifetime and must be replaced. The
Income Tax Act permits a deduction of part
of the capital cost of assets. Capital cost
allowance is the maximum rate set under the
Income Tax Act which the taxpayer can claim
for depreciation. Consequently, accruals for
depreciation are established using this
maximum.
Example of
Accruals for Depreciation
ABC Realty Inc. acquires a specific
piece of equipment. Assume that the
undepreciated value is $12,000 for the
current year and the maximum rate for
depreciation is 10% per year for that class
of asset. The accruals for depreciation for
that year would be $1,200, expensed monthly
at the rate of $100.
As a further example, the condominium
reserve fund established by a condominium
corporation is used to set aside (accrue)
money for major replacement of common
elements such as roofs, exterior finishes,
roads, sidewalks, electrical and plumbing
systems, and recreational facilities. To
ensure that appropriate amounts are
available in contemplation of these
replacements, the corporation may initiate,
or be required by statute to complete, a
reserve fund study for the building.
Incurred expenses that are payable at a
future date. In accrual accounting (often
described as the accounts payable/accounts
receivable method), revenue and expenses are
entered as they are incurred and not when
paid or received.
An accounting method where each item of
revenue or expense is recorded based on the
date such an event occurred without concern
for the actual date of receipt or payment.
Net income is measured as the difference
between revenues and expenses rather than
the difference between cash received and
cash disbursed.
When applying accrual accounting in a
brokerage office, revenue must be viewed in
terms of contingencies and unique qualities
associated with a real estate trade. Two
methods of recording income are used:
Trade Written (Option A): Date the
trade is written.
Trade Closed (Option B): Date the
trade closes.
Option B is more prevalent, given the
uncertainties associated with the completion
of real estate transactions, e.g.,
unfulfilled conditions, fall-through, and
closing delays. However, both approaches
should be seriously evaluated with
consideration for prevailing practices in
the particular market area, any specific
provincial requirements, and appropriate
guidance from an accounting expert.
Two methods of computing income are
permitted from a tax perspective—cash or
accrual. Cash accounting, referred to as a
single entry system , requires that the
taxpayer record any cash received during the
year along with monies expended in the same
period. The difference for that particular
taxation year is the profit or loss.
According to the Income Tax Act, the
cash method can only be used by commissioned
salespeople, farmers, and fishermen, and no
longer applies to a business or profession.
Brokerages are held to be a profession
and must apply the accrual method of
computing expenses and revenue (subject to
considerations as discussed regarding trade
written/trade closed). Accrual accounting
requires a double set of entries, hence the
reference to double entry system. Accrual
accounting makes use of debits and credits
with two accounting entries for any single
transaction: a debit and a credit. Often
described as the accounts payable/receivable
method, revenue and expenses are entered as
they are incurred and not when
paid/received. Figure
bellow describes the accrual method
regarding an expense that flows over a
two-year period.
Example 1
Accrual Accounting
- Cash Accounting
Cash accounting tracks
actual income received and expenses paid at
the time each occurs. For example, if a
commission salesperson received a printing
bill one month ago for $49 and paid it
during the current month, his/her personal
records would reflect the debt today.
Similarly, if a commission of $2,000 is
received during the current month for a sale
effected last month, it would be recorded
during the current month. The difference
between the revenue ($2,000) and the expense
($49) would be a profit of $1,951, with tax
computed on that amount.
Example 2
Accrual Accounting
- Accrual Accounting
In accrual accounting,
using the details of the cash accounting
example and assuming the invoice is received
by a brokerage, the bill would have appeared
in last month’s journal, as the expense was
incurred at that point. If the expense
represented a considerable amount, it could
be prorated over three or four subsequent
months to more accurately portray the
expense in relation to the rate of
consumption. Similarly, the commission
cheque deposited today would not be
reflected in the current month’s income (if
the brokerage had elected to report income
on a date written basis). This revenue entry
would appear during the month the deal was
accepted (perhaps 60 days ago), as a credit
to an accounts receivable account.
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