An accrual allows an entity to record expenses and revenues for which it expects to expend cash or receive cash, respectively, in a future reporting period. Using accruals allows a business to more closely adhere to the matching principle, where revenues and related expenses are recognized together in the same period. It is nearly impossible to generate financial statements without using accruals, unless the cash basis of accounting is used.Examples of accruals are:
- Revenue accrual. A consulting company works billable hours on a project that it will eventually bill to a client for $5,000. It can record an accrual in the current period, so that its current income statement shows $5,000 of revenue, even though it has not yet billed the client.
- Expense accrual - interest. A company has a loan with the local bank for $1 million, and pays interest on the loan at a variable rate of interest. The invoice from the bank for $3,000 in interest expense does not arrive until the following month, so the company accrues the expense in order to show the amount on its income statement in the proper month.
- Expense accrual - wages. A company pays its employees at the end of each month for their hours worked through the 25th day of the month. To fully record the wage expense for the entire month, it also accrues $32,000 in additional wages, which represents the cost of wages for the remaining days of the month.
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 (such as Unbilled Consulting Fees), which also appears in the balance sheet. Thus, the effect of an accrual entry is that a change will occur in the balance sheet, as well as the income statement.
Most accruals are initially created as reversing entries, so that the accounting software automatically cancels them in the following month. This happens when you are expecting revenue to actually be billed, or supplier invoices to actually arrive, in the next reporting period.