Accruals are accounting adjustments used to recognise revenues and expenses in the period in which they are earned or incurred, rather than when cash is received or paid. They are a core element of accrual accounting and ensure that financial statements reflect the true economic activity of a business.
By recording income and costs when they arise, accruals improve the accuracy, consistency, and usefulness of financial reporting↗. Most businesses use accrual accounting because it provides a clearer picture of performance than cash-based accounting, especially when transactions span multiple accounting periods.
What are accruals?
Accruals are entries made at the end of an accounting period to account for transactions that have occurred but have not yet been settled in cash. They exist because business activity does not always align neatly with payment timing.
For example, a company may receive services in one month but pay for them in the next. Without accruals, expenses and revenues would appear in different periods, distorting financial results. Accruals correct this by ensuring that financial statements reflect what actually happened during the reporting period.
How do accruals work?
Accruals generally fall into two categories: accrued expenses and accrued revenues.
Accrued expenses represent costs that a business has already incurred but has not yet paid. Common examples include wages earned by employees but paid in the next payroll cycle, utilities consumed but not yet invoiced, or interest that has accumulated on a loan. These expenses are recognised in the income statement, with a corresponding liability recorded on the balance sheet until payment is made.
Accrued revenues, on the other hand, represent income that has been earned but not yet billed or received. This might occur when services are delivered near the end of a period but invoicing happens later. In these cases, revenue is recognised along with a corresponding asset, typically recorded as accounts receivable↗.
When cash is eventually paid or received, the accrued balance is cleared so the transaction is not recorded twice.
Why are accruals important?
Accruals are essential because they ensure that financial statements accurately reflect business performance. By aligning revenues and expenses with the periods in which they occur, accruals support the matching principle and provide a more realistic view of profitability.
They also make financial results more comparable across periods. Without accruals, fluctuations in payment timing could create misleading spikes or dips in reported income and expenses. Accruals smooth these effects by focusing on economic activity rather than cash flow alone.
From a governance and compliance perspective, accruals help ensure that financial reporting meets accounting standards and provides stakeholders with reliable information.
When are accruals recorded?
Accruals are typically recorded during the period-end close process, whether on a monthly, quarterly, or annual basis. Finance teams review transactions and identify expenses↗ and revenues that relate to the reporting period but have not yet been processed through cash payments or invoices.
This often includes recording employee wages earned through the end of the period, estimating utility costs before bills arrive, or recognising revenue from partially completed contracts. Once the period closes, these accruals ensure the financial statements are complete.
In the following period, accrual entries are reversed or settled when the actual cash transaction occurs.
Accruals vs. cash accounting
Accrual accounting differs significantly from cash accounting↗. Under cash accounting, revenues and expenses are recognised only when money changes hands. While simpler, this approach can give a distorted view of performance when payments are delayed or received in advance.
Accrual accounting, supported by accrual entries, overcomes this limitation by recognising transactions based on economic activity rather than payment timing. This makes it the preferred method for most businesses and a requirement under many accounting standards.
How accruals affect financial statements
Accruals influence both the income statement and the balance sheet. On the income statement, they ensure that revenues and expenses appear in the correct period. On the balance sheet, they create assets or liabilities that represent amounts owed to or by the business at the reporting date.
Together, these effects ensure that financial statements present a complete and balanced picture of a company’s financial position and operating results.
Accruals and multiple currencies
When transactions involve multiple currencies, accruals are typically recorded in the company’s reporting currency using an appropriate exchange rate at period end. This ensures costs and revenues are recognised in the correct reporting period, even if settlement occurs later.
In some cases, accruals may also need to include foreign transaction fees↗ charged by banks or payment providers. When the invoice is received or payment is made, any differences between the accrued amount and the final settled amount, including exchange movements or transaction fees, are recorded as foreign exchange gains or losses. Consistent exchange rate and fee treatment helps keep accruals accurate and comparable across reporting periods.
Managing accruals effectively
Managing accruals well requires consistency and judgement. Finance teams must regularly review outstanding obligations and earned but unbilled revenue, apply reasonable estimates, and adjust accruals when actual amounts become known.
Clear documentation and regular reconciliation help ensure accruals remain accurate over time. Many organisations also rely on accounting software↗ to automate recurring accruals and reduce manual effort, especially as transaction volumes grow.
Summary
Accruals are accounting adjustments that recognise revenues and expenses when they are earned or incurred, not when cash is exchanged. They are fundamental to accrual accounting and play a key role in producing accurate, comparable financial statements. By capturing economic activity in the correct reporting period, accruals help businesses maintain reliable records and make better-informed financial decisions.