What Is the Definition of Accrual in Accounting?

Accrual in accounting recognizes financial events when they occur, regardless of when cash changes hands. This method ensures revenues and expenses are recorded when earned or incurred, providing a comprehensive view of a business’s economic activities over a specific period.

Understanding Accrual Principles

Accrual accounting relies on core principles for a precise picture of business performance. The revenue recognition principle dictates that revenue is recorded when it is earned and realized. For instance, if a consulting firm provides services in December, the revenue is recognized in December, even if the client pays in January. This principle ensures the income statement accurately reflects the value of goods or services provided within an accounting period.

Complementing this is the matching principle, which requires that expenses be recognized in the same period as the revenues they helped generate. If a company incurs costs, such as sales commissions, to make a sale, those expenses are recorded in the same period as the related sales revenue. This connection between efforts (expenses) and results (revenues) offers a clearer depiction of profitability. The matching principle also applies to costs that provide benefits over time, like the depreciation of an asset, which is systematically allocated as an expense across its useful life.

Common Accruals

Accrual accounting involves recognizing two primary types of transactions: accrued revenues and accrued expenses. Accrued revenues, also known as accrued assets or receivables, represent income that a business has earned but has not yet received payment for. This occurs when a service is provided or a product is delivered on credit. For example, a marketing agency completing a campaign for a client in a given month accrues revenue for that service, even if the billing happens later.

Accrued expenses, conversely, are costs that a business has incurred but has not yet paid. These are obligations for goods or services received where an invoice may not have arrived, or payment is due at a later date. Common examples include utilities consumed during an accounting period but not yet billed by the provider, or employee salaries earned for work performed up to the end of a period but not disbursed until the next payroll cycle. Recognizing these expenses when incurred, rather than when paid, aligns costs with the period in which they helped generate revenue.

Accrual Compared to Cash Basis

Accrual accounting fundamentally differs from cash basis accounting in the timing of transaction recognition. Cash basis accounting records revenues only when cash is received and expenses only when cash is paid out. This method provides an immediate view of cash inflows and outflows. It does not account for money owed to the business or money the business owes to others until the cash transaction occurs.

For instance, if a company sells a product on credit in July, accrual accounting recognizes the sale in July, even if payment is received in August. Under the cash basis, that same sale would only be recorded in August when the cash arrives. This distinction means accrual accounting offers a more comprehensive and accurate view of a company’s financial performance and position over a period, especially for businesses that engage in credit transactions.

Accruals on Financial Statements

Accruals have a direct impact on a company’s primary financial statements, providing a more insightful view of its financial standing. On the Income Statement, accrual accounting ensures that revenues and expenses are matched and recognized in the period they occur. This alignment leads to a more accurate representation of a company’s profitability for a given period, as it reflects all economic activities, not just cash movements. For example, sales made on credit and expenses incurred but not yet paid are included, painting a complete picture of earnings.

On the Balance Sheet, accruals appear as assets or liabilities, reflecting amounts earned or incurred but not yet settled in cash. Accrued revenues are presented as current assets, often as Accounts Receivable, indicating money owed to the business. Conversely, accrued expenses are shown as current liabilities, such as Accrued Expenses or Wages Payable, representing obligations the company must pay in the near future. These entries ensure the balance sheet accurately portrays the company’s financial position at a specific point in time, including both settled and unsettled obligations and claims.