What Are Accruals?
Accruals refer to revenues and expenses that have been earned or incurred but have not yet been recorded in the company’s financial statements. Under the accrual accounting method, transactions are recorded when they occur, rather than when cash is exchanged. This method provides a more accurate picture of a company’s financial position by recognizing revenues and expenses in the period they relate to, rather than when payment is received or made.
Accruals are essential for businesses to comply with the matching principle, which ensures that revenues and related expenses are recorded in the same period.
How Accrual Accounting Works
Accrual accounting recognizes two key types of accruals:
- Accrued Revenues – Revenue that has been earned but not yet received in cash or recorded in accounts.
- Accrued Expenses – Expenses that have been incurred but not yet paid or recorded in accounts.
Instead of waiting for cash transactions, businesses record transactions when they occur, adjusting their accounts accordingly.
Key Adjusting Entries for Accruals
At the end of an accounting period, businesses make adjusting journal entries to record accruals. These entries ensure financial statements reflect the true financial position.
- For Accrued Revenue:
- Debit Accounts Receivable (Asset)
- Credit Revenue (Income)
- For Accrued Expenses:
- Debit Expense Account
- Credit Accrued Liabilities or Accounts Payable
Examples of Accrual Accounting
Example 1: Accrued Revenue
A consulting firm provides services worth $5,000 to a client in December but will receive payment in January. Under accrual accounting, the firm records:
- December Entry:
- Debit Accounts Receivable $5,000
- Credit Service Revenue $5,000
This ensures the revenue is recognized in the correct period.
Example 2: Accrued Expenses
A company’s employees earn salaries of $10,000 in December, but payroll is processed in January. The company records:
- December Entry:
- Debit Salaries Expense $10,000
- Credit Salaries Payable $10,000
When the payment is made in January, the entry reverses:
- Debit Salaries Payable $10,000
- Credit Cash $10,000