Definition: Accrual represents revenues and expense, which are not recorded on a firm’s balance sheet; however, they have an impact on the firm’s income and assets that are based on accrual accounting, such as accounts receivable, accounts payable and interest expenses.
What Does Accrual Mean?
What is the definition of accrual? Accrual accounting recognizes adjustments for revenues that are realized by the delivery of the product or the service. Hence, cash has been received, and the revenue needs to be recognized on the balance sheet. It also recognizes expenses related to the recognized revenue, so that the entries in the financial statement match these accrued revenues and expenses. For instance, an employee bonus is an expense for the company. However, it the bonus is earned in the first quarter (Q1), and it is paid in the fourth quarter (Q4), this is an accrued expense for the company. In the financial statements of the next year, the company should record the bonus as an expense.
Let’s look at an example.
Example
Utility bills are the most common example of accruals.
Company XYZ has a manufacturing facility and uses water and electricity from utility companies. The utility companies issue their invoices on a billing cycle, which runs from the 20th of the current month to the 19th of the following month. So, company XYZ receives the current utility bills on the 23rd of the following month and not before.
At the beginning of each month, let’s say, February, the accountant of company XYZ closes the previous month, i.e. January. Because the utility companies do not bill their customers for the current month but for the next month, the accountant pays the utility bills of January in February and of February in March and so on. Therefore, the company’s accountant has to adjust the entries in the financial statement so that the payments of the bills are reported as accrued expenses.
Summary Definition
Define Accruals: Accrual means an expense or revenue that is incurred in a period but not paid for or collected until the next period.
