Accrued means an expense or revenue has been recognised in your books before the money has been paid or received. In accrual accounting, you record transactions when they happen, not when cash changes hands. Itโs the best way to get an accurate picture of your businessโs financial health.
What is accrual accounting?
Accrual accounting is the accrual method of recording financial transactions. You recognise revenue when itโs earned and expenses when theyโre incurred. It doesnโt matter when the payment happens.
Imagine you complete a $5,000 contract in June, but the customer doesnโt pay until July. Youโll still record the revenue in June so that your financial statements reflect the true position for the reporting period.
What are accrued expenses?
Accrued expenses are costs your business has incurred but not yet paid. They are recorded as accrued liabilities on the balance sheet and show up under accounts payable.
A few examples include employee wages earned but not yet paid, utility bills received but unpaid, interest on a loan that has accumulated before the payment date, as well as taxes owed but not yet remitted. You owe these amounts even though no invoice or bill has been settled.
What are accrued revenues?
Accrued revenues are income your business has earned but not yet collected, and they appear as accounts receivable on your balance sheet.
Letโs say you provide consulting services rendered in March but donโt send the invoice until April. In this example, the revenue is still accrued in March. Sales accrued before payment, make sure your income statement reflects the right period.
What is accrued interest?
Accrued interest is interest on a loan or debt that has accumulated but hasnโt been paid or received yet. Youโll notice that itโs a very common form of accrual for any business with borrowing.
If your business has a $100,000 loan at 6% interest, the interest accrues daily. At the end of each period, you record the accrued interest as a liability โ even if the payment isnโt due until the following month.
How is accrual accounting different from cash accounting?
Cash accounting records revenue when money is received and expenses when money is paid. The accrual method records them when they are earned or incurred.
Cash accounting is simpler but gives less visibility into your actual financial position. Accrual accounting gives a clearer picture because it shows all money owed and owing. Most large businesses use the accrual method for their financial reporting.
How do you record accruals?
Start by creating a journal entry with a debit to the expense or revenue account and a credit to the corresponding liability or asset account. When the payment is eventually made, you reverse the accrual.
As an example, to accrue $2,000 in employee wages at month’s end: debit the wages expense account by $2,000 and credit the accrued liabilities account by $2,000. When you pay the employees, all you need to do is debit accrued liabilities and credit cash.
For example:
| General Journal | |||
|---|---|---|---|
| Date | Transaction | Debits | Credits |
| 10/07 |
Wage Expense Accrued Liabilities Monthly Wages |
2,000
|
2,000 |
| 10/07 |
Accrued Liabilities Cash Wages Paid |
2,000
|
2,000 |
Why does accrual accounting matter for your business?
Accrual accounting gives you a complete view of your income, expenses, entitlements, and liability position. It helps managers spot patterns in spending and revenue, stay on top of cash flow, make better business decisions, and plan ahead to leverage long-term growth opportunities.
Without accruals, your financial statements could show misleading results. A business might appear profitable in one period because customers paid advance invoices, whereas the next period might look poor because no money came in. Accrued amounts must be reported accurately to avoid misleading results. Any unpaid bill, invoice, or loan payment is recorded when incurred, not when settled.
Use accounting software to manage accruals automatically. Our bookkeeping and payroll accruals solutions help guarantee your income statement and balance sheet show your true position โ whether youโre tracking contract-based commission percentages, employee benefits, spending on supplies, or loan interest.
If youโre just a sole trader or running a larger company, accrual accounting is generally the better method for solid financial reporting. Why? Because it makes sure your income statement always shows revenue when earned and expenses when incurred.
The result is that it provides managers and investors with the knowledge they need to make sound decisions and manage cash flow effectively.
If youโre not sure whether to use cash accounting or accrual accounting, speak with your accountant or financial advisor. Most businesses with employees, inventory, or credit sales will benefit from the accrual method, as it provides a complete and accurate picture of their financial position at any point in time.
See related terms
What is a ledger?
What is cash flow?
What are fixed assets?
