What is an accrual?
An accrual is an accounting entry that records when a company incurs expenses or revenue, but the cash transaction has yet to happen.
Accrual accounting is the method used by accountants to record accruals. Accruals appear both on the balance sheet and income statement of the financial statement. Accounts receivable and accounts payable are two common types of accruals. Accruals represent an accurate picture of the company’s finances since they record each transaction when it occurs and not when the cash is exchanged.
If a company provides services or sells its products to clients, it is recorded as revenue in its financial statement even if the client hasn’t paid it yet. Similarly, If a company has received services or supplies, but hasn’t paid the supplier or service provider yet, it will count as an accrued expense in the balance sheet.
How accrual works
Accrual is the preferred method of accounting by the generally accepted accounting principles (GAAP). The accountant records adjustments for accrued revenue by including it as revenue in the income statement. You see a debit of the same amount in the associated accrued revenue account on the balance sheet. Accountants make adjusting journal entries to the company’s general ledger after each accounting period to ensure the financial statements are accurate. Adjusting journal entries accounts for any unrecognized income or expense within that accounting period.
An alternative to accrual accounting is cash accounting, which only records transactions after cash is exchanged. This is risky because the company may show itself as being much less profitable than it actually is. Businesses that work on credit with their clients and make a huge profit are not covered in this.
Why accrual is important
Accrual accounting can help mainly because businesses can take stock of and plan their short-term expenses and calculate their revenue. Accruals reflect the company’s true financial position: the status of the company’s revenues, expenses, liabilities, and assets. This is important for investors, creditors, and tax authorities who require regular updates about the company’s growth. Cash flow alone cannot give an accurate picture of how much the business is thriving.