An accrual is an expense or income generated when no invoice or payment has been made at the end of that period. Accruals allow an organization to maintain detailed records of revenues and expenditures, even if payment has not yet completed or obtained for goods or services provided,
Accruals are used for:
- Benefits that an organization has already taken but for which amount has not yet received,
- Services that have already given but the payment is, however, to be received.
Types of accruals
Revenues are recorded as and when they arise and not when they are received or settled correctly.
For example, Michael’s company sold chairs to company X on December 10 and had a revenue of £ 850. Under the accrual accounting basis, Michael’s company marks the £850 income in their records as Debtors or accounts receivable on December 10 of the current accounting period, even though they will obtain payment in the next accounting period.
Expenses are also recorded in the same accounting period regardless of any payment made received by the company.
For example, Jack purchases kitchen supplies from ABC group on November 5. Delivery of supplies took place after 3-4 days. ABC group charges Jack a total of £2100, due within 30 days. Jack marks this as an expense in his records for November 5, even though he will make the payment in the following accounting period.
It is a method used by firms to monitor their financial transactions at the point they occur, irrespective of whether a cash payment has made or not.
When a corporation follows the accrual accounting method, economic events are recognized in its accounts by matching revenues with expenditures (the matching principle) when the transaction takes place (not when the payments are made).
The accrual accounting method enables the actual cash inflows and outflows to get displayed alongside the estimated future cash inflows and outflows. This method gives an accurate picture of the financial position of the company.
Example of accrual accounting
An ABC airline company sells its tickets days, weeks or even months before the flight takes place, but the receipts are not recorded as income, because the event (i.e. flying) on which the revenue is based has not yet taken place.
So, the entry would be:
Bank a/c debited to unearned revenue. This unearned revenue will be converted into revenue when the flight will take place.