Accrue
Definition:
Accruing involves recording an event in the accounting records, capturing income or expenses at the time they are earned or incurred, regardless of whether the associated cash has been received or paid. This is in line with the accrual basis of accounting, which contrasts with the cash basis that records transactions only when cash changes hands.
Examples:
- Accrued Income Tax: A company may accrue its income tax expense at the end of a fiscal year to reflect the tax liability for that year, even though the actual payment will be made in the following year.
- Accrued Wages: If a company’s payroll period doesn’t align exactly with the month-end, employees’ salaries earned but not yet paid by the month-end are accrued.
- Accrued Interest: When interest on a loan accumulates over time but has not yet been paid, it is recorded in the books as an accrued interest expense.
Frequently Asked Questions (FAQs)
What is the purpose of accruing expenses in accounting?
Accruing expenses is essential to match income and expenses in the period they are incurred, providing a clearer picture of a company’s financial status based on the principles of the accrual accounting method.
What distinction exists between accrued expenses and accounts payable?
Accrued expenses are recognized when incurred before receiving an invoice; accounts payable are liabilities recorded upon receipt of an invoice.
How does revenue accrual work?
Revenue accrual occurs when revenue is recognized upon the delivery of goods or services, even if payment has not been received.
What is the impact of ignoring accruals in financial statements?
Ignoring accruals results in inaccurate financial statements which can mislead stakeholders by not fully recognizing a company’s liabilities or receivables.
Can small businesses use accrual accounting?
Yes, small businesses can use accrual accounting, and it is often required if their annual gross receipts exceed a certain threshold, depending on jurisdiction.
- Accrual Basis: An accounting method that records revenues and expenses when they are incurred, rather than when cash is exchanged.
- Cash Basis: An accounting method that records transactions only when cash is received or paid. Not typically used for businesses with large revenues due to potential for misrepresentation of financial status.
- Accounts Payable: Liabilities that result from purchasing goods or services on credit, representing amounts owed to suppliers.
- Deferred Revenue: Revenue received for goods or services which have not yet been delivered, recorded as a liability until delivery.
Online Resources
Suggested Books for Further Studies
- “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
- “Financial Accounting and Reporting” by Barry Elliott and Jamie Elliott
- “Accounting Principles” by Jerry J. Weygandt, Paul D. Kimmel, and Donald E. Kieso
Fundamentals of Accrual Accounting: Accounting Basics Quiz
### Does recording an accrued expense affect the cash flow statement immediately?
- [ ] Yes, it immediately affects cash flow.
- [ ] Only for income taxes.
- [x] No, cash flow is affected when the payment is made.
- [ ] Only if the expense is large.
> **Explanation:** Accrued expenses are recorded in the income statement when incurred but affect the cash flow when payment is actually made.
### What is the primary objective of the accrual basis of accounting?
- [ ] To delay expense recognition.
- [x] To match revenues with corresponding expenses.
- [ ] To recognize cash payments.
- [ ] To ensure immediate payment of all liabilities.
> **Explanation:** The accrual basis aims to match revenues with related expenses within the same period, ensuring accurate reflection of financial performance.
### Accrued wages are an example of:
- [ ] Deferred Revenue
- [ ] Fixed Asset
- [x] Accrued Liability
- [ ] Long-term Debt
> **Explanation:** Accrued wages are considered accrued liabilities as they represent salaries earned by employees not yet paid by the reporting date.
### What happens to accrued revenue when payment is finally received?
- [ ] It is written off.
- [ ] It remains unchanged.
- [ ] The cash flow statement is unaffected.
- [x] It is moved from accrued revenue to cash.
> **Explanation:** When payment for accrued revenue is received, the amount is reclassified from accrued revenues (accounts receivable) to cash.
### According to the accrual basis of accounting, when should revenue be recognized?
- [ ] When it is invoiced.
- [x] When it is earned.
- [ ] When cash is received.
- [ ] When the bank balance is confirmed.
> **Explanation:** According to the accrual basis of accounting, revenue is recognized when earned, regardless of cash receipt.
### In what scenario might a company accrue tax expenses?
- [ ] When taxes are paid.
- [ ] When filing tax returns.
- [ ] During the accrual period, before payment.
- [x] At the end of the fiscal year.
> **Explanation:** Companies often accrue tax expenses at the end of the fiscal year to reflect them in the year they are incurred, even if payment is made later.
### How does failing to accrue expenses impact financial reporting?
- [x] It misrepresents the company's true liabilities.
- [ ] It ensures more cash on hand.
- [ ] It reduces complexity.
- [ ] It affects only cash basis accounting.
> **Explanation:** Not accruing expenses misrepresents a company's liabilities, skewing financial results and potentially misleading stakeholders.
### What is the difference between accrual basis and cash basis accounting?
- [ ] Timing of expense recognition.
- [ ] Approach to liability management.
- [x] Timing of when transactions are recorded.
- [ ] Treatment of long-term assets.
> **Explanation:** The key difference lies in the timing of recording transactions; accrual basis records when transactions happen, regardless of cash flow, while cash basis records only when cash is exchanged.
### How should a company handle an unbilled but completed service at year-end?
- [ ] Ignore it until billed.
- [ ] Bill it immediately.
- [x] Accrue the revenue.
- [ ] Record as deferred revenue.
> **Explanation:** The company should accrue the revenue for the completed service even if it hasn't been billed yet to reflect the earned income accurately.
### How does accrued interest affect financial statements?
- [ ] Increases cash assets.
- [ ] Decreases liabilities.
- [ ] Increases equity.
- [x] Increases expenses and liabilities.
> **Explanation:** Accrued interest increases expenses on the income statement and increases liabilities on the balance sheet until the payment is made.
Thank you for delving into the intricacies of accrual accounting with this overview and quiz. Accurate financial reporting is essential for business transparency and decision-making.
