Accruals: How This Accounting Concept Works
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In accounting, an accrual is an amount of money owed to or by a business. Accruals take place whenever future payments are promised for goods or services. They also include other types of anticipated inflows or outflows of cash, like rent.
An accrual happens on both the seller and buyer sides: A business that sends a $100 invoice to a client expects an inflow of $100, and the client plans on an outflow of $100.
The way a business accounts for accruals on its balance sheets and income statement depends on whether it uses the accrual or the cash basis method of accounting.
Accrual vs. cash basis accounting
If a business uses the accrual method of accounting, revenue is recorded when it’s earned, even if payment occurs later. If a business purchases something but pays later, the purchase is recorded when it's made.
Some businesses use the cash basis method of accounting, which records transactions only when dollars move in or out of an account. This method of accounting is simple and straightforward, making it popular among some small-business owners. However, because revenues and expenses aren’t recorded until money moves into or out of a bank account, accruals do not appear on balance sheets. As a result, this method could hamper understanding a business’s performance when reviewing its financial statements. The more common accrued revenue and expenses are, the bigger this effect can be.
All of NerdWallet’s top accounting software for small businesses lets users choose between accrual and cash basis accounting. These include:
Quickbooks Online |
FreshBooks Accounting |
Xero.
Xero |
Zoho Books |
Examples of accruals
An invoice issued for a good or service is a common source of accruals. The business issuing the invoice would record the amount as accrued revenue, while the buyer would record the amount as an accrued expense.
Accrued expenses can also be estimates rather than final amounts owed. Examples include:
Interest on a loan.
Taxes.
Rent payments.
Utility payments.
Wages owed to employees.
Benefits of accrual accounting
Keeping track of accrued revenue and expenses involves recording an initial transaction when payment is owed and a second transaction once it’s paid or received. While it’s twice the work of creating a single entry, this method can give organizations deeper insight into their business, allowing them to plan more effectively.
For example, a lawn care business might offer three-month contracts for lawn service, providing weekly mowing to customers and billing monthly. Without using the accrual method, it would be tough to project labor and equipment needs, which occur daily, over a multi-month period. It would also be hard to know whether there was enough money in the bank to pay employees when employee paydays and customer billing due dates don’t align. By using accrual accounting, the business can project future cash flows to accommodate these different time frames.
Where to find accruals on your financial statements
Accrued expenses appear in the liabilities section of your balance sheet and the expenses portion of your income statement. Depending on your business, you might subdivide your outstanding accrued expenses among various accounts payable — wages payable and taxes payable, for example.
Accrued revenues show up as an asset under accounts receivable on your balance sheet and as income on your income statement.
In both cases, your cash account balance will offset the accrual whenever you make or receive the payment in the future.
