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All About Accruals

This eBook presents three methods for accruing—or estimating—utility use and cost. The content is most relevant for energy managers, accountants, and other organization stakeholders tasked with utility bill accounting, utilities budgeting, and analysis of utility billing information. A working knowledge of utility bill data and rate schedules is helpful but not necessary.

To an engineer, accruals are an accounting exercise that doesn’t really add anything to the energy management picture, so they can be hard to love. But for those in accounting departments and those dealing with utility budgets, accruals are very important and necessary.

What is an accrual?

An accrual is basically a gap-filling estimate that is necessary to complete an accounting period, so we can close out an accounting period with a utility expense in every daily slot of the accounting period.

Here’s a scenario: our organization has multiple accounts representing utility bills and utility meters, and the end of an accounting period is approaching. The problem is that oftentimes when we get to the end of the accounting period, we have a gap between the utility vendor’s meter read date (i.e., the end date of utility bills) and the end of the accounting period. You can’t control when your utility vendors read the meters.

Typically, utility companies read meters based upon a meter reading route that is based upon certain zones or certain districts. You can’t just call a utility company and say, “Can you read my meter on the 21st instead of on the 13th?” With the advent of smart meters, we might see more of the ability to select your own meter reading and billing date, but today we’re kind of stuck with whatever our utility vendors do for us. So, you are getting ready to close out the accounting period and find this jagged ending to your various utility accounts that leave gaps in the accounting record.

In what scenario are accruals used?

Accruals are most frequently used by for-profit businesses that have very structured fiscal period profit and loss statements. These are organizations that, for various reasons, need to produce a P&L at the end of every accounting period.

Accruals are frequently employed, for example, at retail organizations where the store manager’s bonus is based upon the profit loss statement for the end of each financial period. We know for the entire fiscal period what the rent or lease amount was. We know what the salary and benefits expenses were. And we know what marketing expenses were. But when the electric bill ended 15 days before the end of the end of the accounting period, and we won’t even see the utility bill that includes those 15 days for another two weeks, we need to fill in that gap with an expense estimate so we can complete the P&L statement for the organization. Accruals provide a more accurate close at the end of each fiscal period.

Some organizations, universities for instance, don’t really care about the individual month, but they do care about the end of the fiscal year. A lot of nonprofit organizations are on fund accounting. Government would also be a good example on fund accounting.

You frequently hear the expression, “Use it or lose it.” Let’s say the end of the fiscal year is June 30. We don’t want to lose unexpended funds on July first because they weren’t used, when, in reality, a utility bill is going to be received on July 14th that’s going to include 15 days from June. We would like to set that 15 days of electric bill aside at the end of June so we have the funds in that fiscal year’s money and can spend it when the bill comes in.

Method 1: Average Daily Cost

There are three common methods for creating utility bill accruals. The first one is what we call the “simple cost-per-day,” using the most recent bill. As the name implies, we get our most recent utility bill—the one that just came in the door maybe a week ago—and we calculate the average daily cost (ADC) from that utility bill.

The bill just received, for instance, was running at $1,000 a day in the most recent billing period, and we simply multiply the average daily cost times the number of days in the accrual gap. It is a simple calculation that yields a reasonable value for accrual cost. Note that this method doesn’t give us a usage value for accrual, but it gives us a reasonable accrual cost. You also need to be aware of seasonality.

If this is an account that is steady throughout the year, then the ADC you calculated is probably a very close estimate. But if your electric bills in the summer are much higher than they are in the winter, as you’re moving from winter to summer by looking back a month, you’re looking at a bill that is coming out of the low period and projecting it forward into a higher period. So, you might be under-accruing. And on the other side of the season, you’re looking back at an expensive summer high air-conditioning bill and projecting that forward into a period that’s more mild, so you’re over-accruing. Of course, if you over-accrue expense, you’re going to underestimate the calculated profit and vice versa at the other time of the year. Seasonality is sometimes a concern using the simple ADC method.

Method 2: Historical Approach

Accrual method number two is more precise and, to engineers, feels like a better, more rigorous process. Instead of looking backwards at just the most recent bill, this method looks at the bill for the same period last year and maybe the year before that. So, if we’re accruing a March bill, the best estimate of March consumption does not come from my February bill. It comes from my March bill last year, and maybe the year before that, or the year before that. You may want to look back one to three years and average all those together.

In this method, we take the same monthly use-per-day, but we don’t want to take the cost from last year because rates may have changed. The best unit cost often comes from last month, so we calculate the average daily usage (ADU) from the same month in prior years, then take the average unit cost (AUC) from last month’s bill. That is a better estimate of the prevailing average unit cost. We multiply average daily usage times average unit cost of most recent bill, times the number of days in the accrual gap.

Method 3: Interval Data

The third method of creating accruals is based on actual interval data. Now that a lot of commercial buildings, especially larger buildings, have smart meters on them, it is reasonable to ask, “If I have a smart meter for which I want to create an accrual, don’t I already know from my smart meter exactly how much I’ve consumed in the accrual gap? Why don’t I just use the interval data and apply the rate schedule to it?” 

Let’s say today is the end of your accounting period, and you want to create an accrual that “fills in” the past two weeks, because it was two weeks ago when you received your last electric bill. If you have ready access to smart meter data, it may be near real-time, or, at worst, you’re getting it a day in arrears. Either way, if you have access to the data, you can use it.

You need to access the interval readings that begin with the read date (i.e., end date) of the most recent bill and add up all of those 15-minute intervals to get to the end of your accounting period. That will provide you with your actual usage, which should match or be very close to the usage on your utility bill when you receive it. Note, that if you have to create the accrual before the end of the accounting period, then this method doesn’t work too well, because you might have one or more days until the last day of the accounting period, and you don’t have smart meter data for those days yet. You’ll need to look at your situation, and when you’re generating the accruals, determine if this method is going to work.

You’ve calculated the usage accrual, but how do you calculate the cost? In theory, you can apply the utility company rate schedule to the calculated usage. However, you’ll need to be careful about rate complications. It’s not as simple as just taking the utility company rate arithmetic and applying some kWh to it. Due to the way demand charges are assessed, you don’t want to apply a full month’s worth of demand charge to a five- or seven-day accrual. That’s just not an accurate way to do it. You might want, instead, to go back to last month’s actual bill, get the average unit cost, and just apply a blended average unit cost to the kilowatt hours for the consumption that you’ve calculated.

Now Reverse It All

Now we have one or more accruals in the system. What do we do with them?

At some point in time, you will want to remove the accruals, because when the real bills come in, you don’t want the real bill to be sitting on top of an accrual for a partial billing period. Leaving the accrual in the system will result in some number of days’ worth of consumption being counted twice. You will want to, in some way, get rid of the accrual, and there are a couple ways to do it.

One method of accrual reversal is to simply delete the accrual out of the database—like it never existed—when you receive the actual bill, or even beforehand. You may also void the accrual, so that it stays in the database, but for all intents and purposes, it is invisible. Whether you delete the accrual or void it, the result is the same. You’re making it go away.

An alternative is to keep the accrual in the system, so you can report on it but reverse it by creating an equal and opposite transaction. In other words, you create a transaction that shows negative consumption and cost amounts that match the use and cost numbers in the accrual. That way, when you run a report, it will negate the original accrual.

Why is the latter option preferred? We recommend the reversal option because some accounting systems don’t want transactions to be deleted or voided. The preference is to get rid of a transaction by reversing it via an equal and opposite transaction. Bottom line: The reversal is the better accounting and audit trail practice.

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