What it means
Accrual accounting rests on one idea: record income when it is earned and costs when they are incurred, not when the cash arrives or leaves. An accrual is the bookkeeping entry that makes that happen for anything still unbilled or unpaid when the period closes.
The reason this matters is comparability between periods. If a December electricity bill is only recorded when it is paid in February, December looks unusually profitable and February looks unusually poor, and neither month reflects the trading that really took place.
Accruals push each cost back into the month that consumed it. In practice the finance team runs an accruals review at each month end, listing everything the business has used but has not been billed for.
Typical items are wages for days worked after the last payroll run, utilities, professional fees, goods received without an invoice, and interest building up on loans. Each one is posted as a cost in the profit and loss account with a matching liability on the balance sheet.
The entry is then reversed when the real invoice arrives so the cost is not counted twice. A good finance team compares each accrual with the invoice that eventually lands, because the size of the gap is a direct measure of how reliable its estimates are.
Two neighbouring ideas often get confused with accruals. A prepayment is the mirror image, cash paid in advance for something not yet consumed, and a provision is an estimate of a cost whose timing or amount is genuinely uncertain.
Accruals sit between them: the cost is real and reasonably measurable, and only the paperwork is missing.
In practice
Real-world examples
Example 1
A marketing agency closes its March accounts knowing the annual audit fee of $18,000 relates to the year just ended, even though the invoice will not arrive until July. It accrues the full $18,000 in March so the cost sits in the year the audit work relates to.
Example 2
A manufacturer takes delivery of $64,000 of steel on 29 June with no supplier invoice yet raised. The goods received note supports an accrual of $64,000 at 30 June, keeping the raw material cost in the same period as the production it fed.
Example 3
A software business pays sales commission quarterly in arrears and knows that $47,000 has been earned by the team during the final month of the quarter. Accruing it means the commission cost appears in the same month as the revenue that generated it rather than a month later.
Think of it
Think of accruals like writing down in your planner that you owe someone a favor or they owe you, even if you haven't actually done the favor or received it yet. It helps you keep track of what's going on even if it hasn't happened yet.
Formula
Calculation
Accrual = value of goods or services consumed in the period - amounts already invoiced for that period.
A company runs a monthly payroll of $180,000 covering a 30-day month, which is a daily cost of $180,000 / 30 = $6,000. The December pay run covered work up to and including 26 December, leaving five days of December unpaid at the year end.
The accrual is 5 x $6,000 = $30,000, posted as a wages cost in December with a matching accrued liability of $30,000 on the balance sheet at 31 December. If December profit before this entry looked like $95,000, the reported figure becomes $95,000 - $30,000 = $65,000, which is the more honest number because those five days of work belong to December. When January's payroll is paid, the accrual is reversed so January is not charged twice for the same five days.Case study
Seen in the real world
Harbour Lane Interiors is an illustrative and entirely fictional fit-out contractor that spent its first two years reporting on a cash basis. Its monthly profit swung wildly, with strong months whenever subcontractor invoices were slow to arrive and terrible months when three of them landed together.
When the owner approached a bank for a facility, the lender struggled to read the numbers and asked for accounts prepared on an accruals basis. The bookkeeper introduced a month-end routine that accrued subcontractor work certified but not invoiced, utilities, and part-month wages, and reversed each accrual when the invoice appeared.
The reported profit for the year barely changed, but the monthly pattern became readable and the seasonal dip in February was visible for the first time. The bank approved the facility, and the owner used the smoothed figures to renegotiate payment terms with two subcontractors whose late billing had been distorting the picture.
Watch out
Common mistakes
- Assuming accruals change how much profit a business makes over its life, when they only change which period the income or cost falls into.
- Forgetting to reverse an accrual in the following month, which double counts the cost once the supplier invoice is posted.
- Treating accruals as optional housekeeping rather than the basis on which lenders, investors and tax authorities expect the accounts to be prepared.
Questions
People also ask
What is the difference between an accrual and a provision?
An accrual covers a cost that is certain and reasonably measurable, while a provision covers an obligation whose amount or timing is genuinely uncertain.
Do accruals affect cash flow?
Not directly, which is why a profitable set of accruals-based accounts can still sit alongside a tight bank balance.
Who decides the size of an accrual?
The finance team estimates it from contracts, rate cards, timesheets or delivery records, and the auditors test those estimates against the invoices that arrive later.