Definition of Accrual
Accrual (also referred to as accrued charge, accrued expense, or accrued liability) is a financial accounting term that denotes an estimate of a liability that is recorded in a company’s accounts despite not being accompanied by an invoice or a payment request at the time the accounts are prepared. Accruals ensure that expenses are recognized in the accounting period to which they pertain, reflecting a more accurate financial position.
Examples of Accruals
- Utilities Expense: A company may not receive a bill for electricity usage until the first week of the following month. To accurately reflect this expense in the correct accounting period, an accrual is made based on the estimated usage and cost.
- Wages and Salaries: If a pay period does not align exactly with the month-end, wages earned by employees but not yet paid are accrued. This means recognizing an expense in the correct month.
- Interest Expense: If a company owes interest on a loan, but the payment isn’t due until the following period, the interest incurred up to the end of the current period would be accrued.
Frequently Asked Questions (FAQ)
What is the purpose of an accrual?
The purpose of an accrual is to ensure expenses and revenues are recorded in the accounting period to which they relate, providing a more accurate financial picture in accordance with the matching principle.
How is an accrual recorded?
An accrual is recorded by debiting the relevant expense account and crediting an accrual or liability account. When the invoice is eventually received, the liability account is debited, and the bank account or payable account is credited.
What is the difference between an accrual and a provision?
An accrual is an estimated expense or revenue that has been incurred but not yet invoiced, while a provision is an estimation for a future liability or expense that is anticipated but uncertain in amount or timing.
When should an accrual be reversed?
An accrual should be reversed when the actual expense is recognized or paid. This is typically in the subsequent accounting period.
Are all expenses subject to accrual?
Not all expenses need accruals. Only those for which the invoice has not yet been received or paid but pertain to the current accounting period should be accrued.
- Current Liability: A financial obligation that must be settled within a year.
- Balance Sheet: A financial statement that provides a snapshot of an organization’s financial position at a specific point in time.
- Profit and Loss Account: Also known as an income statement; it summarizes revenues, costs, and expenses incurred during a specific period.
Online References
Suggested Books for Further Studies
- Intermediate Accounting by Donald E. Kieso, Jerry J. Weygandt, Terry D. Warfield
- Financial Accounting by Robert Libby, Patricia A. Libby, Frank Hodge
- Principles of Accounting by Belverd E. Needles, Marian Powers
Accounting Basics: “Accrual” Fundamentals Quiz
### What is an accrual in accounting?
- [ ] A method of recording transactions only when cash changes hands.
- [x] An estimate of a liability that is recognized without an invoice or payment request.
- [ ] A record of all cash transactions in a period.
- [ ] An entry made only when payments are overdue.
> **Explanation:** An accrual is an estimate of a liability that is recorded even when no invoice or payment request has been received, ensuring that expenses are recorded in the period they relate to.
### Which financial statement typically includes accruals?
- [ ] Cash Flow Statement
- [ ] Income Statement
- [ ] Statement of Owner's Equity
- [x] Balance Sheet
> **Explanation:** Accruals are typically recorded on the balance sheet as current liabilities, reflecting expenses that have been incurred but not yet invoiced or paid.
### What principle governs the use of accruals?
- [ ] Cost Principle
- [x] Matching Principle
- [ ] Historical Cost Principle
- [ ] Revenue Recognition Principle
> **Explanation:** The matching principle requires that expenses are matched to the revenues of the period they relate to, justifying the use of accruals to better align expenses with revenues.
### Which account is credited when recording an accrued expense?
- [ ] Accrued Revenue Account
- [x] Accrued Liabilities Account
- [ ] Prepaid Expenses Account
- [ ] Owner's Equity Account
> **Explanation:** When recording an accrued expense, the accrued liabilities account is credited to recognize the unpaid expense, while the expense account is debited.
### What should be done with an accrual in the subsequent period?
- [ ] It should be ignored.
- [ ] It should be repeated.
- [x] It should be reversed.
- [ ] It should be capitalized.
> **Explanation:** In the subsequent period, an accrual should typically be reversed to prevent duplicate entries when the actual expense is recognized or paid.
### When are wage expenses usually accrued?
- [ ] At the end of the fiscal year.
- [ ] Only after employees are paid.
- [x] At the end of the accounting period if they span the period end.
- [ ] Only when a new employee is hired.
> **Explanation:** Wage expenses are accrued at the end of the accounting period if the pay period spans the period end, to ensure the expense is recognized in the correct period.
### What differentiates an accrual from a prepayment?
- [ ] An accrual records future payments.
- [ ] An accrual is always a cash transaction.
- [x] An accrual records expenses incurred but not yet paid, while a prepayment records expenses paid but not yet incurred.
- [ ] An accrual does not appear on financial statements.
> **Explanation:** An accrual records expenses that have been incurred but not yet paid, whereas a prepayment records expenses that have been paid but not yet incurred.
### Is an accrual usually a current or long-term liability?
- [ ] Long-term Liability
- [x] Current Liability
- [ ] Equity
- [ ] Not a liability
> **Explanation:** An accrual is typically a current liability as it represents an obligation to make a payment within a short period, generally within one year.
### Which type of expense is a good example of an accrual?
- [x] Utilities bills not yet invoiced by the vendor.
- [ ] Purchases made using a company credit card.
- [ ] Depreciation expense on a building.
- [ ] Prepaid insurance.
> **Explanation:** Utilities bills that have not yet been invoiced by the vendor are a common type of accrual, representing expenses incurred but not yet paid or invoiced.
### What action should be taken once the actual invoice for an accrued expense is received?
- [ ] Adjust the capital balance.
- [x] Reverse the accrual and record the actual expense.
- [ ] Ignore the accrual as paid.
- [ ] Record a new accrual.
> **Explanation:** Once the actual invoice is received, the initial accrual should be reversed, and the actual expense recorded to reflect the accurate financial position.
Thank you for enhancing your accounting knowledge with our comprehensive examination on accruals. Keep expanding your financial expertise!
