The Horizontal Model to Show the Effects of Payroll on Accrual

by Jared Lewis
Accrual accounting requires business to keep up-to-date records.


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The horizontal method provides accountants with a simple means of analyzing various expenses on an income statement. Most accounting firms and company accounting departments use the accrual method of accounting, in which revenue and expenses are accounted for as they accrue or during the accounting period in which they occur. The horizontal method can show those in charge of the books how payroll affects accrual at any given period.


The horizontal model for accrual accounting places the totals of the balance sheet side by side with a company's income statement. On the left side of the model is the balance sheet, which show the company's assets. Assets are equal to a company's liabilities plus its owners' equity. On the other half of the horizontal chart is the income statement. A company's net income is simply a matter of subtracting its expenses from its income. An arrow on the chart points from net income back to the left side of the horizontal chart. This arrow indicates that the net profits of a company affect the retained earnings. Retained earnings make up part of the owners' equity.


Adjustments to either the income statement or the balance sheet describe the accruals that take place. When one side of the model is considered in light of the other, one single equation can be written as: Assets=Liabilities + Owners’ Equity + Income – Expenses. This means that payroll adjustments made to the income statement are listed as expenses an are subtracted from company income to obtain a net income amount. An increase in company payroll would then result in a corresponding decrease in company assets on the balance sheet.


Accounting for the effects of payroll on the balance sheet requires that those responsible for recording the adjustments make both an addition and a subtraction. In accrual accounting, the balance sheet must "balance out" in the end. Payroll affects the company's liabilities because this is money that the company is obligated to pay. This results in a corresponding decrease in the owners' equity. However, if payroll decreases, the opposite will occur, causing the owners' equity to increase and the liabilities to decrease.


The horizontal model provides an easy tool for analysis of a company's financial position and the role that payroll plays in that financial health. McGraw-Hill Higher Education recommends asking a series of questions when making adjustments. These questions are designed to help make sense of what takes place when adjustments are made to the income statement and balance sheet. For instance, simply asking the questions, "Which accounts are affected?" or "Does the balance sheet balance?" provides a way to step back from the information and put it all together. Remembering that one side of the equation affects the other is at the heart of accrual accounting analysis.

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