Why are accruals needed every month?
/What are Accruals?
Accruals allow a business to record expenses and revenues for which it expects to expend cash or receive cash, respectively, in a future period. They are an essential element of the accrual basis of accounting. It is nearly impossible to generate financial statements without using accruals, unless the cash basis of accounting is used.
Reasons for Monthly Accruals
There are several reasons why monthly accruals are needed every month. They are as follows:
To recognize unbilled revenue. If a firm is issuing financial statements every month, then it needs to create accruals for each set of financials. One reason for doing so is to recognize revenues earned during the month for which there have been no billings to customers. For example, a consulting firm conducts work for the government during a month, but is not allowed to bill the government until the project has been completed, which will not be for several months. In this case, the firm should accrue for the earned but unbilled revenue.
To recognize unbilled expenses. A business may need to recognize expenses incurred during the month for which no supplier invoices have yet arrived. For example, a manufacturing firm receives a shipment of widgets from a supplier near the end of the month, but no supplier invoice has been received as of the date when financial statements are supposed to be issued. In this case, the firm should accrue for the incurred but unbilled expense.
The use of accrual transactions is a common component of the monthly close when a business employs the accrual basis of accounting. This basis of accounting is required when a company wants to have its books audited at the end of its fiscal year.
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FAQs
Do Accruals Improve the Comparability of Financial Statements?
Accruals improve comparability of financial statements by ensuring that revenues and expenses are recorded in the periods they relate to, regardless of cash timing. This consistency allows for more accurate period-to-period analysis of financial performance. Without accruals, timing differences in cash flows could distort trends and make comparisons unreliable.
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