Accruals are an accounting concept used to record and report revenues and expenses that have not been paid for, received, or incurred. The concept is important to financial managers because it serves as a fundamental part of how a firm’s financial information is accurately measured and presented.
Definition
Accruals are accounting entries that record future obligations or revenues when they occur, rather than when they are received or paid. As such, accruals provide a means of recognizing and reporting changes in a company’s liabilities or assets in a given period. Accruals enable companies to accurately assess and report the financial performance of the business for a given period, as required by generally accepted accounting principles.
Importance
Accruals are an important part of modern financial management and reporting. Accounting entries based on accruals are the most reliable indicators of accurate financial information and are required for compliance with generally accepted accounting principles and applicable financial reporting regulations. Accruals also ensure companies recognize and record expenses and revenues causally, rather than according to the cash and credit terms associated with them.
Basics of Accruals
Accruals are based on the matching principle, which states that expenses and associated revenues must be recognized in the same accounting period. Accruals involve the use of adjusting journal entries to record expenditures, income, or other transactions that have taken place in the current period, but will not be settled or paid until the next period.
In general, accruals are categorized as follows:
* Deferred Revenue: Deferred revenue is recorded when a company recognizes revenue in the current period for transactions or services that are expected to be provided in the future.
* Accounts Payable: Accounts payable accruals are recorded when a company has received goods or services in the current period, but has not yet paid for them.
* Accrued Expenses: An accrued expense is recorded when the company has incurred a cost in the current period but the actual payment of the expense has not been made.
Key Considerations
When using the accrual method of accounting, financial managers should consider the following:
* Maintaining accurate records is paramount to ensure that entries are properly matched and reported.
* Accrual accounting should be used in conjunction with cash-basis accounting to provide a comprehensive view of the company’s financial status.
* When a new transaction or expense is posted, make sure to adjust any relevant accrual accounts to ensure accuracy.
Real-World Example
An example of an accrual entry would be the recognition of revenue for a service provided in the current period but not billed until the next period. For example, for a subscription-based service, a company may recognize the revenue for the service in the period it was provided, rather than in the period when payment is received.
Conclusion
Accruals are important accounting entries and an essential part of good financial management. Accrual accounting enables companies to accurately track, report, and assess their financial performance in accordance with generally accepted accounting principles, while the matching principle helps ensure that revenue and the associated expenses are recognized in the same period. Accrual entries must be properly documented and adjusted to ensure accuracy, and should be used in conjunction with cash-basis accounting as a comprehensive view of the company’s financial situation.
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