What are Accruals
Accruals are earned revenues and incurred expenses that have an overall impact on an income statement. They also affect the balance sheet, which represents liabilities and non-cash-based assets used in accrual-based accounting. These accounts include, among many others, accounts payable, accounts receivable, goodwill, future tax liabilities and future interest expenses.
BREAKING DOWN Accruals
The use of accrual accounts has greatly increased the amount of information on accounting statements. Before the use of accruals, accountants only recorded cash transactions on these statements. But cash transactions don't give information about other important business activities, such as revenue based on credit and future liabilities. By recording accruals, a company can measure what it owes in the short-term and also what cash revenue it expects to receive. It also allows a company to show assets that do not have a cash value, such as goodwill.
Using the accrual method, an accountant makes adjustments for revenue that has been earned but is not yet recorded in the accounts, and expenses that have been incurred but are not yet recorded in the accounts. The accruals must be added via adjusting journal entries, so that the financial statements report these amounts.
In double-entry bookkeeping, the offset to an accrued expense is an accrued liability account, which appears in the balance sheet. The offset to accrued revenue is an accrued asset account, which also appears in the balance sheet. Therefore, an accrual entry will impact the balance sheet and the income statement.
Accruals are revenues and expenses that are incurred during an accounting period for which no invoices or payments were received or made. Accruals are, therefore, estimated figures since the invoice, when received, may have different numbers. When invoice has been received, a company records the amount under the accounts payable (for money owing suppliers and vendors) or accounts receivable account (for money to be collected from customers) in the balance sheet.
Let's look at an example of an accrual regarding revenue that involves an electric utility company. The utility company generated electricity that customers received in December. However, the utility does not bill the electric customers until the following month. To have the proper amounts on the utility's financial statements, there needs to be an adjusting entry to report revenue that was earned in December, which reflects the receivables that the utility has a right to as of December 31. The following month, when the cash is received, the receivables will go down, and the cash account will increase.
An example of an accrual involving an expense is employee bonuses that were earned in 2016, but will not be paid until 2017. The 2016 financial statements need to reflect the bonus expense and the bonus liability. Therefore, prior to issuing the 2016 financial statements, an adjusting entry records this accrual. The accountant increases an expense and creates a liability. Once the payment has been made in the new year, the liability will be eliminated, and the cash will be reduced.
Another expense accrual occurs for interest. For instance, a company with a bond will accrue interest expense. Interest on bonds is typically paid semi-annually, but the interest expense will be recorded as the amount that has accrued as of the date of the financial statement. A corresponding interest liability will be recorded on the balance sheet.