What is Accrual?
Accrual refers to recording income and expenses in accounting records at the time economic activities occur, regardless of whether the money has been received or paid. It is a principle-based accounting method aimed at providing accurate and comprehensive financial information. The accrual principle is adopted and applied in many countries' accounting standards and International Financial Reporting Standards (IFRS) for preparing financial statements and conducting financial analysis. By applying the accrual principle, companies can more accurately measure their revenue, expenses, profits, and liabilities, offering more comprehensive financial information for stakeholders to make decisions and assessments.
Main Items of Accrual
Accrual mainly involves the following items:
- Accrued Revenue: Income that has been earned but not yet received in cash. When a company provides goods or services but has not yet received payment, the corresponding income is recorded as accrued revenue.
- Accrued Expenses: Expenses that have been incurred but not yet realized. For example, a company has incurred accrued insurance costs or retirement benefit expenses.
- Accrued Expenses: Expenses that have been incurred but not yet paid. When a company uses a service or product but has not yet paid the related fees, the corresponding expenses are recorded as accrued expenses.
- Accrued Interest: Interest that has been earned but not yet paid. For example, a borrower needs to pay accrued interest before the loan matures, which is recorded as accrued interest in accounting.
- Accrued Liabilities: Debts that have been incurred but not yet paid or settled. This might include wages, taxes, and interest expenses, which are recorded as accrued liabilities in accounting.
- Accrued Income: Income that has been earned but not yet realized. For example, dividends or interest income earned from investments held by a company.
Advantages of Accrual
- Reflects Real Economic Activities: The accrual principle ensures that financial statements accurately reflect the economic activities of a company within a specific accounting period. It allows companies to record income and expenses that have occurred but not yet realized or paid, providing more accurate financial information.
- Provides Comprehensive Financial Information: The accrual principle helps provide more comprehensive financial information. By recording accrued items, financial statements can reflect all revenue and expenses, not just cash inflows and outflows. This aids investors, creditors, and other stakeholders in comprehensively understanding a company’s financial position and operating performance.
- Supports Financial Analysis and Decision Making: The accrual principle provides more accurate data for financial analysis and decision-making. By including accrued items in financial statements, analysts and management can better evaluate a company's performance and operations, leading to more informed decisions.
- Increases Financial Statement Comparability: Applying the accrual principle helps improve the comparability of financial statements. Different companies may have different cash receipt and payment timings, but the accrual principle ensures consistent recording at the time of economic activity, making financial statements more comparable.
- Complies with Accounting Standards and Regulations: The accrual principle is part of accounting standards and regulations, which companies need to follow when preparing financial statements. Adhering to the accrual principle helps companies comply with relevant laws and regulations, ensuring the conformity and reliability of financial statements.
Operation Process of Accrual
- Identifying Accrued Items: Determine the income or expenses that have occurred but not yet realized or paid within the accounting period. This may involve accrued revenue, accrued expenses, accrued interest, accrued liabilities, etc.
- Recording Accrued Items: According to the accrual principle, record the relevant accrued items in the accounting records. This means recording at the time income or expenses occur rather than when cash is actually received or paid.
- Determining Measurement Basis: Establish the measurement basis for the amount of accrued items. This may involve measuring based on contract terms, market prices, or other reliable data.
- Disclosing in Financial Statements: Disclose information about accrued items in the financial statements. This is usually explained in the balance sheet, income statement, or notes to ensure that relevant information is correctly understood by investors, creditors, and other stakeholders.
- Adjusting and Carrying Forward: At the end of the accounting period, adjust accrued items to accurately reflect the company's financial position. This may involve adjusting cash that has been realized or paid and converting corresponding accrued items to actual or paid ones.
Types of Accrual
Accrued Receivables and Accrued Payables are accounting concepts used to describe receivables and payables that have not yet been actually received or paid by a company.
Accrued Receivables
Accrued receivables refer to income that has been generated but not yet received by the end of an accounting period. This means the company has fulfilled its obligation to deliver goods or services but has not yet received the corresponding payments. Accounting standards require companies to recognize these receivables in financial statements to reflect economic substance.
Example: A company provided services or sold goods but has not issued an invoice to the customer or received payment. At the end of the accounting period, the company will list the corresponding revenue as accrued receivables based on the amount of the completed services or goods sold.
Accrued Payables
Accrued payables refer to expenses or debts that have been incurred but not yet paid by the end of an accounting period. This indicates that the company has accepted goods or services but has not yet made the payment. Accounting standards require companies to recognize these payables in financial statements to reflect economic substance.
Example: A company receives raw materials or services from a supplier but has not yet been invoiced or made payment. At the end of the accounting period, the company will list the corresponding expenses as accrued payables based on the amount of the received raw materials or services.
