To accrue means to accumulate over time—most commonly used when referring to the interest, income, or expenses of an individual or business. Interest in a savings account, for example, accrues over time, allowing the total amount in that account to grow. The term ‘accrue’ is often related to accrual accounting, which has become the standard accounting practice for most companies.
Key Takeaways
- Accrue involves the accumulation of interest, income, or expenses over time, such as interest in a savings account.
- When something financial accrues, it essentially builds up to be paid or received in a future period.
- Accrue is often associated with accrual accounting, which includes accrued revenue and accrued expenses.
- Accrued revenue occurs when a company has sold a product or service but has yet to be paid for it.
- Accrued expenses are expenses that are recognized before being paid, such as certain interest expenses or salaries.
How Accrue Works
When financial elements accrue, they essentially build up to be paid or received in a future period. Both assets and liabilities can accrue over time. The term ‘accrue’ is synonymous with an ‘accrual’ under the accounting methods outlined by Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
An accrual is an accounting adjustment used to track and record revenues earned but not received, or expenses incurred but not paid. Think of accrued entries as the opposite of unearned entries—like accrued entries, the corresponding financial event has already taken place but payment has not been made or received.
Accepted and mandatory accruals are determined by the Financial Accounting Standards Board (FASB), which controls interpretations of GAAP. Accruals can include accounts payable, accounts receivable, goodwill, future tax liability, and future interest expense.
Special Considerations
The accrual accounting procedure measures a company’s performance and position by recognizing economic events regardless of when cash transactions occur, providing a better picture of the company’s financial health and causing asset or liability adjustments to ‘build up’ over time.
This is in contrast to the cash method of accounting, where revenues and expenses are recorded when funds are actually paid or received, leaving out revenues based on credit and future liabilities. Cash-based accounting does not require adjustments.
While some small or new businesses use cash accounting, most companies prefer the accrual accounting method. Accrual accounting gives a far better picture of a company’s financial situation because it records not only the company’s current finances but also future transactions.
For example, if a company sold $100 worth of product on credit in January, it would want to record that $100 in January under the accrual accounting method rather than wait until the cash is actually received, which may take months or may even result in a bad debt.
Types of Accrues
All accruals fall into one of two categories: revenue or expense accrual.
Accrued Revenue
Revenue accruals represent income or assets (including non-cash assets) yet to be received. These accruals occur when a good or service has been sold, but payment has not been received from the customer. Companies with large amounts of credit card transactions usually have high levels of accounts receivable and accrued revenue.
Assume that Company ABC hires Consulting Firm XYZ to assist on a project that is estimated to take three months to complete. The fee for this job is $150,000, to be paid upon completion. While ABC owes XYZ $50,000 after each monthly milestone, the total fee accrues over the course of the project instead of being paid in installments.
Accrued Expense
Whenever a business recognizes an expense before it is actually paid, it can make an accrual entry in its general ledger. The expense may also be listed as accrued in the balance sheet and charged against income in the income statement. Common types of accrued expenses include:
- Interest expense accruals – These occur when interest is owed on debt before receiving the invoice.
- Supplier accruals – These occur when goods or services are received from a supplier on credit and the company plans to pay the supplier later.
- Wage or salary accruals – These occur when a company pays employees before the end of the month for a full month of work.
Interest, taxes, and other payments sometimes need to be put into accrued entries whenever unpaid obligations should be recognized in the financial statements. Otherwise, the operating expenses for a certain period might be understated, which would result in net income being overstated.
Salaries are accrued whenever a workweek does not neatly correspond with monthly financial reports and payroll. For example, if payroll is done on January 28 but employees work on January 29, 30, or 31, those workdays still count toward January operating expenses. An accrued salary account is used to account for those salary expenses.
There are various rationales for accruing specific expenses. The general purpose of an accrual account is to match expenses with the accounting period during which they were incurred. Accrued expenses are also effective in predicting the amounts the company can expect to see in the future.
Related Terms: assets, liabilities, GAAP, IFRS, financial health, cash accounting, accounts payable, accounts receivable.
References
- Financial Accounting Standards Board. “Standards”.
