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What are Accruals?
Accruals represent revenues earned or expenses incurred that have not yet been recorded in a company’s financial statements because cash has not yet been exchanged. They are key adjustments under the accrual accounting system to ensure accurate financial reporting.
Definition
Accruals are accounting adjustments made at the end of a reporting period to recognize income or expenses in the period they occur, even if cash transactions happen later.
Key Takeaways
- Recognize income and expenses before cash settlement.
- Ensure compliance with the matching and revenue recognition principles.
- Recorded as accrued revenues or accrued expenses.
- Adjusted at period-end for accurate financial statements.
- Found on the balance sheet as assets or liabilities.
Understanding Accruals
Accruals bridge the timing gap between when transactions occur and when cash is exchanged. They are essential for providing an accurate financial picture in accrual accounting.
Two Main Types of Accruals
- Accrued Revenues: Income earned but not yet received (e.g., services provided but not yet billed).
- Accrued Expenses: Costs incurred but not yet paid (e.g., wages payable, interest payable).
These entries ensure that revenues and expenses are matched within the same reporting period, supporting reliable profit measurement.
Formula (If Applicable)
No direct formula, but accruals follow:
Revenue Accrual = Revenue Earned − Cash Received
Expense Accrual = Expense Incurred − Cash Paid
Example:
If a firm earns $10,000 in December but invoices in January, a revenue accrual of $10,000 is recorded in December.
Real-World Example
A consulting company delivers services worth $50,000 in December, payable in January. It records accrued revenue of $50,000 in December to reflect the work performed.
Similarly, a manufacturing company records accrued wages for employees who worked in December but are paid in January.
Importance in Business or Economics
Accruals are critical for:
- Accurate matching of income and expenses within periods.
- Financial transparency for stakeholders.
- Compliance with GAAP/IFRS accounting standards.
- Supporting budgeting, performance tracking, and valuation.
Economically, accruals ensure reported profits align with real economic activity rather than cash flow timing.
Types or Variations
- Accrued Revenues: Earned income not yet received.
- Accrued Expenses: Incurred obligations not yet paid.
- Adjusting Accruals: End-of-period entries to update accounts.
- Reversing Accruals: Entries made at the start of a new period to avoid duplication.
Related Terms
- Accrual Accounting
- Matching Principle
- Deferred Revenue
- Prepaid Expenses
- Accounts Receivable
Sources and Further Reading
- IFRS Foundation – Conceptual Framework for Financial Reporting.
- FASB – ASC 606: Revenue Recognition.
- Investopedia – Accruals.
- Corporate Finance Institute (CFI) – Adjusting Entries and Accruals.
Quick Reference
- Purpose: Record transactions before cash is exchanged.
- Key Principles: Matching and revenue recognition.
- Location: Balance sheet and income statement.
- Example: Accrued wages, interest, and revenue.
- Relevance: Enhances financial statement accuracy.
Frequently Asked Questions (FAQs)
Why are accruals important?
They ensure income and expenses are recognized in the period they occur, improving accuracy.
Are accruals assets or liabilities?
Accrued revenues are assets; accrued expenses are liabilities.
When are accruals reversed?
Typically at the start of the next accounting period.
What’s the difference between accruals and deferrals?
Accruals record before cash flow; deferrals delay recognition until after cash is exchanged.
