AccrualÂ (accumulation) of something is, inÂ finance, the adding together of interestÂ or differentÂ investmentsÂ over a period of time. It holds specific meanings inÂ accounting, where it can refer to accounts on aÂ balance sheetÂ that represent liabilities and non-cash-based assets used in accrual-based accounting. These types of accounts include, among others,Â accounts payable,Â accounts receivable,Â goodwill,Â deferred taxÂ liabilityÂ and future interest expense.
For example, a company delivers a product to a customer who will pay for it 30 days later in the nextÂ fiscal year, which starts a week after the delivery. The company recognizes the proceeds as aÂ revenueÂ in its currentÂ income statement still for the fiscal year of the delivery, even though it will get paid in cash during the followingÂ accounting period.Â The proceeds are also anÂ accrued income(asset) on theÂ balance sheetÂ for the delivery fiscal year, but not for the next fiscal year when cash is received.
Similarly, a salesperson, who sold the product, earned a commission at the moment of sale (or delivery). The company will recognize the commission as an expenseÂ in its current income statement, even though the salesperson will actually get paid at the end of the following week in the nextÂ accounting period. The commission is also anÂ accrued expenseÂ (liability) on theÂ balance sheetÂ for the delivery period, but not for the next period the commission (cash) is paid out to the salesperson.
The termÂ accrualÂ is also often used as an abbreviation for the termsÂ accrued expenseÂ andÂ accrued revenueÂ that share the common name word, but they have the opposite economic/accounting characteristics.
- Accrued revenue: revenue is recognized before cash is received.
- Accrued expense: expense is recognized before cash is paid out.
Accrued revenueÂ (orÂ accrued assets) is anÂ asset, such as unpaid proceeds from a delivery of goods or services, when such income is earned and a relatedÂ revenueÂ item is recognized, while cash is to be received in a latter period, when the amount is deducted from accrued revenues.
In the rental industry, there are specializedÂ revenue accrualsÂ for rental income which crosses month end boundaries. These are normally utilized by rental companies who charge in arrears, based on an anniversary of a contract date. For example a rental contract which began on 15 January, being invoiced on aÂ recurringÂ monthly basis will not generate its first invoice until 14 February. Therefore at the end of the January financial period an accrual must be raised for sixteen days worth of the monthly charge. This may be a simple pro-rata basis (e.g. 16/31 of the monthly charge) or may be more complex if only week days are being charged or a standardized month is being used (e.g. 28 days, 30 days etc.).
Accrued expenseÂ is aÂ liabilityÂ whose timing or amount is uncertain by virtue of the fact that an invoice has not yet been received. The uncertainty of the accrued expense is not significant enough to qualify it as aÂ provision. An example of an accrued expense is a pending obligation to pay for goods or services received from a counterpart, while cash is to be paid out in a latterÂ accounting period when the amount is deducted fromÂ accrued expenses.