What are Accruals?
Accruals are adjustments that must be made before a company’s financial statements are issued to reflect the revenues earned or expenses incurred that have not yet been recorded in the company’s books.
Accruals are based on the accrual method of accounting, which recognizes revenues and expenses when they are earned or incurred, regardless of when cash is received or paid.
It involves the following types of business transactions:
- Accrued revenues: These are earnings obtained from providing goods or services to clients which have not been invoiced or received yet. A consulting company that finishes a project for a customer in December, but bills them in January, would record an accrued revenue in December.
- Accrued expenses: These are expenses that have been incurred by using goods or services from suppliers but have not yet been paid or recorded. For example, a company that uses electricity in December, but does not receive the bill until January, would record an accrued expense in December.
- Deferred revenues: These are revenues that have been received in advance from customers but have not yet been earned by providing goods or services. For example, a magazine publisher that receives a subscription fee in December for a one-year subscription starting in January would record a deferred revenue in December.
- Deferred expenses: These are payments made in advance for future goods or services. An instance is when a company pays rent in December for January’s use, resulting in the recording of a deferred expense in December.
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Accruals are important because they ensure that the company’s financial statements accurately reflect its true financial performance and position, even if cash has not yet changed hands.
Accruals also help to match revenues and expenses to the periods in which they occur, which is required by generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS).