Definition
To accrue (verb) means to build up gradually over time. In finance and accounting it usually refers to interest, income, or expenses that have been earned or incurred but not yet received or paid. An accrual is therefore an accounting entry that recognizes that economic event in the period when it happens, even if cash flows occur later.
How accruals work (brief)
– Accrual accounting records revenues when they are earned and expenses when they are incurred, regardless of cash movement. This contrasts with cash-basis accounting, which records only when cash changes hands.
– An accrual takes the form of a journal entry that creates or adjusts an asset (for accrued revenue) or a liability (for accrued expense), and simultaneously affects the income statement so that the period’s performance reflects the event.
Key types of accruals
– Accrued revenue: Revenue for goods or services provided but not yet collected in cash. Typical account: Accounts Receivable (or Accrued Revenue).
– Accrued expense: Costs that have been incurred but not yet paid. Typical accounts: Accrued Liabilities, Salaries Payable, Interest Payable, Taxes Payable.
Why companies use accruals
– Matches income and expenses to the period in which they occur (matching principle), giving a clearer view of financial performance and position.
– Required under most standard accounting frameworks (e.g., GAAP and IFRS) for businesses of a certain size or public reporting status.
– Prevents understatement of expenses or revenues that would otherwise distort net income.
Special considerations
– Estimation: Some accruals require judgment (e.g., warranty expense, bad-debt expense). Estimates should be reasonable and documented.
– Reversals: Temporary accrual entries are often reversed in the next accounting period when the actual cash payment or receipt is recorded.
– Disclosure: Material accruals and the assumptions behind estimates should be disclosed in financial statements.
– Small businesses: Some small or new businesses may use cash accounting instead of accruals for simplicity; that choice affects comparability.
Checklist for recording an accrual
1. Identify the event that gives rise to revenue or expense in the current period.
2. Measure the amount to record (use invoice, contract terms, or a reasonable estimate).
3. Select the correct accounts (e.g., Accounts Receivable or Accrued Liabilities).
4. Prepare the journal entry: debit the related expense or asset; credit revenue or liability as appropriate.
5. Document the rationale and any assumptions used for later review.
6. Reverse the accrual in the period when cash is actually received or paid, if applicable.
7. Disclose material accruals and estimation methods in notes to the financial statements.
Worked numeric example — Consulting contract (step-by-step)
Scenario: Consulting Firm XYZ is hired by Company ABC for a fixed fee of $150,000 to be paid at completion. The project lasts three months and ABC recognizes that $50,000 of the fee corresponds to work completed each month.
How XYZ records accrued revenue each month:
– At the end of Month 1 (work done = $50,000) XYZ makes this journal entry:
– Debit Accounts Receivable (or Accrued Revenue) $50,000
– Credit Consulting Revenue $50,000
– Repeat the same entry at the end of Month 2 for the next $50,000.
– At completion (end of Month 3) XYZ records the final $50,000 the same way, and when cash is received, it will debit Cash and credit Accounts Receivable.
Effect on financial statements:
– Income statement: $50,000 revenue recognized each month, improving monthly net income compared with cash basis.
– Balance sheet: Accounts Receivable increases by $50,000 each month until cash collection.
Alternative (expense accrual example — unpaid payroll)
Scenario: Payroll is paid on Jan 28, but employees work Jan 29–31 (three days) before month-end. Those three days are owed but unpaid at month-end.
Calculation and entry:
– If weekly payroll for an employee is $700 (five workdays), per-day cost = $140.
– Accrued salary for the three days = 3 × $140 = $420.
– Journal entry at Jan 31:
– Debit Salary Expense $420
– Credit Salaries Payable (Accrued Payroll) $420
– When payroll is paid on the next pay date, debit Salaries Payable and credit Cash.
Quick formula references
– Accrued revenue entry: Debit Accounts Receivable (asset) — Credit Revenue
– Accrued expense entry: Debit Expense — Credit Accrued Liabilities (liability)
Sources for further reading
– Investopedia — Accrue definition and examples: https://www.investopedia.com/terms/a/accrue.asp
– Financial Accounting Standards Board (FASB) — Standards and guidance: https://www.fasb.org/standards
– IFRS Foundation — International financial reporting standards: https://www.ifrs.org
– U.S. Securities and Exchange Commission — Accounting and reporting basics: https://www.sec.gov/education/accounting-and-reporting
Educational disclaimer
This explainer is for educational purposes and does not constitute individualized investment, accounting, or tax advice. For specific transactions or complex accounting questions, consult a licensed accountant or financial professional.