Business, Legal & Accounting Glossary
The accumulation or increase of something over time, especially payments or benefits.
Accrual (accumulation) of something is, in finance, the adding together of interest or different investments over a period of time.
There are certain expenses that are paid quite some time after they have been used. Electricity is a good example. Whilst you are using electricity the cost is accruing. If the business does not account for these costs in the correct accounting periods that the expense is incurred then the account would be inaccurate.
In most cases the electricity bill is sent every three months. If your business receives an electricity bill in April for electricity it has used in January to March and it has not been accounted for in the accounts, the accounts for January to March will be inaccurate.
The profit in each of these months would have been overstated. To account for this correctly, the business would set up an Accruals account, which is a liability account – this is money that the business owes but has not yet paid.
Most businesses know from experience how much the quarterly electricity bill is likely to be. In view of this, a 1/3 of that quarterly electricity bill is allocated to the electricity expenses account for each month. The transactions would be a debit to the electricity account and a credit to the accruals account each month.
The profit and loss report will show an expense for electricity costs and the balance sheet will show an accruals balance as a liability. This will increase each month until the electricity bill is received.
Once the bill has been received there is no longer a liability, therefore the accrual can be reversed. To do this you would then debit the accruals account and credit the electricity account equal to the amount of the accrual, in order to clear down (reset to zero) the balance. Then finally, the actual amount for the electricity bill would be paid by a debit to the electricity account and a credit to the bank account.
Discuss the main reasons why typical accrual accounting methodologies are not suitable for future decision making.
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This glossary post was last updated: 15th February, 2020