An accrual is an accounting method that records expenses and revenues when they happen, not when cash changes hands. This approach gives businesses a clearer view of their financial health by capturing activity as it occurs instead of waiting for cash to flow.
What is the purpose of accruals?
Accruals help businesses keep their financial records straight by ensuring that income and expenses are recorded in the right period. The main benefits include:
- Accurate financial reporting: Shows the real performance of the business by recognizing revenue and expenses when they occur.
- Regulatory compliance: Financial regulations, like GAAP, often require businesses to use accrual accounting.
- Better decision-making: Helps businesses plan and budget by showing a clear picture of what they owe and what they’ve earned.
- Matching principle: Ensures that revenue and expenses are matched in the same period for more accurate financial statements.
What is the difference between payable and accrual?
Both terms deal with obligations, but they’re not the same:
- Accruals: These are revenues earned or expenses incurred but not yet recorded. Examples include unpaid invoices, salaries, and interest.
- Payables: Money a business owes to suppliers or vendors for goods and services already received. Payables are recorded as accounts payable on the balance sheet.
In short, accruals track financial activity before cash changes hands, while payables deal with money already owed and waiting to be paid.
What are accruals examples?
Accruals can apply to both revenue and expenses. Here are a few examples:
- Revenue accruals:
- A company provides consulting services in December but doesn’t get paid until January. The revenue is recorded in December when the service was delivered.
- A business earns interest on an investment in a quarter but doesn’t receive the payment until the next quarter. The interest is recorded when it accrues.
- Expense accruals:
- A company’s employees work in December but aren’t paid until January. The salaries are accrued in December to match the actual work period.
- A business uses utility services in one month but pays the bill the next. The expense is recorded when the service is used, not when the bill is paid.
Accruals are important for keeping financial reports accurate, making sure income and expenses are shown in the right periods.
