Accruals
Accruals are accounting adjustments made for revenues and expenses that have been incurred but are not yet recorded in the financial statements. This concept is central to accrual accounting, which recognises economic events regardless of when cash transactions occur.
Key Points of Accruals
Revenue Accruals: Income that has been earned but not yet received or recorded in the accounts. For example, if a company provides goods or services in December but will not receive payment until January, the revenue should be recorded in December to align with the period in which it was earned.
Expense Accruals
Costs that have been incurred but not yet paid or recorded in the accounts. For instance, if a company receives a service in December but will not pay for it until January, the expense should be recorded in December to reflect the true cost of operations for that period.
Importance of Accruals
Matching Principle: Accruals support the matching principle of accounting, which states that expenses should be recorded in the same period as the revenues they help to generate.
Accurate Financial Reporting: Ensures that financial statements accurately reflect all earned revenues and incurred expenses within the accounting period, providing a true view of the company's financial position and performance.
Periodicity Assumption: Helps in dividing financial activities into specific periods, making it easier to compare performance over different timeframes.
Common Types of Accruals
Accrued Revenues: Revenues for goods or services that have been delivered but not yet invoiced to the customer.
Accrued Expenses: Expenses for goods or services that have been received but not yet paid or invoiced.
Accrued Interest: Interest that has been earned but not yet received or paid.
Accrued Salaries and Wages: Employee compensation that has been earned but not yet paid.
Examples
Accrued Revenue Example: A consultancy completes a project in June but invoices the client in July. The revenue is accrued in June.
Accrued Expense Example: A company uses electricity in December but receives the bill in January. The expense is accrued in December.
Journal Entries
For Accrued Revenue:
Debit Accounts Receivable
Credit Revenue
For Accrued Expense:
Debit Expense Account
Credit Accounts Payable
Accruals are vital for achieving an accurate and fair representation of a company’s financial status, ensuring compliance with accounting standards such as the UK Generally Accepted Accounting Principles (UK GAAP) or International Financial Reporting Standards (IFRS).