What Are Accruals?

What Are Accruals?

Let me explain accruals directly to you: they're revenues you've earned or expenses you've incurred where the cash hasn't exchanged hands yet. Under accounting standards, your company still has to record both types of these under accrual accounting.

Accruals reflect money you've earned or owed that hasn't changed hands. For instance, you might work a day but not get your paycheck until later. This kind of transaction needs to be on the books per GAAP and IFRS, since the revenue or expense actually happened—it just hasn't been paid yet.

Key Takeaways

Here's what you need to grasp: an accrual is a transaction that's occurred but the cash hasn't moved yet. Without accruals, companies would only report income and expenses tied to cash flows in and out of their accounts.

In accrual accounting, you as an accountant have to enter, adjust, and track revenues and expenses from when they're earned or incurred until they're paid. There are four types: accrued expenses, prepaid expenses, accrued revenue, and deferred revenue. Accruals also lead to accounts like payables, where you owe money, and receivables, where someone owes you.

Understanding Accruals

Businesses aren't usually cash-only anymore. They sell products or services now and get paid later. In accrual accounting, you need to account for these uncollected revenues. The same goes for expenses—if your company incurs one, record it even if unpaid.

Take an accrued expense like a tax bill; it relates to last year's earnings and isn't due right away. Accrued revenue could be a sale on credit. Without accruals, you'd only see cash-related income and expenses, which might not show the real economic activity in each period. For example, if payment for last year's work comes this year, your statements wouldn't match the activity properly.

Accrual Accounting vs. Cash Accounting

The alternative to accrual is cash accounting, where you only record money when it hits or leaves your bank account. It's simple, but accrual requires recording revenue when earned and expenses when incurred, not just when cash moves.

Cash accounting is common for smaller companies because it's easier, while larger ones must use accrual for a truer financial picture. Imagine collecting payment for a service but not paying expenses yet at year-end—cash accounting might make you look more profitable than reality.

Recording Accruals

With accrual accounting, you enter, adjust, and track from earning or incurring to payment. Use double-entry: each transaction has a debit and credit.

For earned but unpaid revenue, debit accounts receivable on the balance sheet and credit revenue on the income statement—this boosts both. For incurred but unpaid expenses, debit expenses on the income statement and credit accounts payable on the balance sheet, increasing expenses and obligations.

Types of Accruals

There are four main types you should know. Accrued expenses, or liabilities, are costs incurred but not paid, like utility bills—electricity used in October might be paid in December, so record it as accrued.

Prepaid expenses are paid upfront before full use, logged as assets, like a lawyer's retainer. Accrued revenue is when you deliver but haven't been paid, like goods on credit—record it as a receivable asset.

Deferred revenue is payment received before delivery, set up as a liability, like advance payments for subscriptions or online orders.

Examples of Accruals

Prepaying or paying later is common. For utilities, you use electricity and pay later after the bill—record as accrued expense by debiting expense and crediting payable. The utility records accrued revenue by debiting receivable and crediting revenue.

Taxes, interest, wages, and bonuses are often paid later too. Account for them in the period incurred under accrual.

The Bottom Line

Prepaying or paying later happens often—accruals cover money earned or spent but not yet paid. In accrual accounting, record these on your income statement and balance sheet before cash moves. If you only document after payment, statements could mislead and not reflect the period accurately. That's why GAAP and IFRS favor accrual.