In bookkeeping and accounting, an “accrual” refers to the recognition of revenue or expenses on the financial statements before the corresponding cash transactions have occurred. Accruals are accounting entries made to ensure that financial statements reflect a company’s financial performance and financial position accurately, matching revenues and expenses with the periods in which they are earned or incurred, rather than when cash changes hands. Accruals are used in accrual accounting to provide a more complete and accurate picture of a business’s financial activities.
There are two primary types of accruals:
- Accrued Revenue: This involves recognizing revenue that has been earned but not yet received in cash or recorded in the accounting books. It typically arises when a company provides goods or services to a customer on credit. Examples of accrued revenue include:
- Interest income earned but not yet received from loans or investments.
- Service fees for work performed but not yet billed to the customer.
- Rent income that is due but not yet collected from tenants.
To record accrued revenue, a company would make a journal entry that debits an appropriate revenue account and credits an accrued revenue or accounts receivable account.
- Accrued Expenses: Accrued expenses are incurred costs that have been recorded in the accounting books but have not yet been paid in cash. This often happens when a company receives goods or services before being billed or when it incurs an expense that will be paid in a future accounting period. Examples of accrued expenses include:
- Utility bills incurred but not yet paid.
- Employee salaries and wages earned but not yet paid.
- Interest expenses that have accrued on outstanding loans but not yet paid.
To record accrued expenses, a company would make a journal entry that debits an appropriate expense account and credits an accrued liability or accounts payable account.
Accruals are essential in accrual accounting because they help ensure that financial statements accurately reflect the economic events that have taken place during a specific accounting period. By matching revenues and expenses to the period in which they are earned or incurred, accruals provide a more comprehensive view of a company’s financial performance and enable better financial decision-making and reporting in compliance with generally accepted accounting principles (GAAP). These entries are typically adjusted at the end of an accounting period to reflect the actual cash transactions when they occur.
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