Accruals explained

Introduction

This tutorial will provide a clear understanding of accruals, including expense and revenue accruals, and how to properly record them in financial statements. Understanding accruals is essential for finance professionals and business leaders to adhere to the matching principle in accounting, which ensures that expenses and revenues are recognized in the same period.

Step 1: Understand the Concept of Accruals

• Accruals are accounting adjustments made for expenses that have been incurred but not yet billed, and revenues that have been earned but not yet recorded.
• Recognizing accruals helps businesses maintain accurate financial records and comply with accounting principles.

Step 2: Differentiate Between Expense and Revenue Accruals

• Expense Accruals:

  • Made when expenses have been incurred but no invoice has been received.
  • Example: If you received consulting services in December but the invoice arrives in January, you would record an expense accrual in December.

• Revenue Accruals:

  • Made when goods or services have been delivered, but the customer has not yet been billed.
  • Example: If you completed a project in December but send the invoice in January, you would record a revenue accrual for December.

Step 3: Create Expense Accruals

• Identify expenses incurred during the accounting period.
• Record the accrual by making a journal entry:
  • Debit the appropriate expense account (e.g., Consulting Expense)
  • Credit the Accrued Liabilities account

Example journal entry:

Debit: Consulting Expense  $1,000
Credit: Accrued Liabilities $1,000

Step 4: Create Revenue Accruals

• Identify any revenues earned but not yet billed.
• Record the accrual by making a journal entry:
  • Debit the Accrued Receivables account
  • Credit the appropriate revenue account (e.g., Consulting Revenue)

Example journal entry:

Debit: Accrued Receivables  $1,500
Credit: Consulting Revenue    $1,500

Step 5: Handle Manual Accruals

• Manually track and adjust for accruals at the end of each accounting period.
• Keep a record of any known future expenses or revenues to ensure accurate reporting.
• Communicate with your team to gather information on any transactions that may require accruals.

Step 6: Review and Adjust Accruals Regularly

• At the end of each accounting period, review all accruals to ensure they are still valid.
• Adjust any accruals based on actual invoices received or payments made.

Conclusion

Understanding accruals is vital for accurate financial reporting and adhering to the matching principle. By differentiating between expense and revenue accruals, creating proper journal entries, and regularly reviewing them, you will enhance your financial acumen. For further learning, consider exploring related topics such as deferrals and prepaid expenses, which are equally important in the realm of accounting.