Definition of Accruals
The accounting and bookkeeping term accruals refers to adjustments that must be made before a company's financial statements are issued. Accruals involve the following types of business transactions:
- expenses, losses, and liabilities that have been incurred but are not yet recorded in the accounts, and
- revenues and assets that have been earned but are not yet recorded in the accounts
Example of an Accrual of an Expense
One example of an accrual of an expense and liability is a major repair that occurs in the final month of the accounting year, but is not paid until the bill is received in the first month of the following year. For the current year's financial statements to be complete (under the accrual method of accounting) the following is necessary:
- the income statement for the current year must report the repair expense, and
- the balance sheet as of the last day of the year must report the related liability
To record this accrual, an adjusting entry is made that debits Repairs Expense and credits Accrued Expenses Payable.
Example of an Accrual of Revenues
One example of an accrual of revenues occurs at your electric utility company. For instance, during December the utility likely uses natural gas and/or coal plus many employees to generate the electricity used by its customers in December. However, the utility does not bill its customers for that electricity until after it reads the meters in January. As a result, the utility's financial statements will need an accrual adjustment so that:
- its income statement for the month of December and for the current year will report all of the revenues earned by the utility, and
- its December 31 balance sheet will report a current asset for the amount it has a right to receive from its customers (including the amount for the electricity it provided in December)
The accrual adjustment will debit the current asset account Accrued Receivables and will credit the income statement account Accrued Electricity Revenues.