Accrual (accumulation) of something is, in finance, the adding together of interest or different investments over a period of time. It holds specific meanings in accounting, where it can refer to accounts on a balance sheet that represent liabilities and non-cash-based assets used in accrual-based accounting. These types of accounts include, among others, accounts payable, accounts receivable, goodwill, deferred tax liability and future interest expense.[1]
For example, a company delivers a product to a customer who will pay for it 30 days later in the next fiscal year, which starts a week after the delivery. The company recognizes the proceeds as a revenue in its current income statement still for the fiscal year of the delivery, even though it will get paid in cash during the following accounting period.[2] The proceeds are also an accrued income (asset) on the balance sheet 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 anexpense in its current income statement, even though s-/he will actually get paid at the end of the following week in the next accounting period. The commission is also a accrued expense (liability) on the balance sheet for the delivery period, but not for the next period the commission (cash) is paid out to her/him.
Unfortunately, the term accrual is also often used as an abbreviation for the terms accrued expense and accrued revenue 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 revenue (or accrued assets) is an asset, such as unpaid proceeds from a delivery of goods or services, when such income is earned and a related revenue 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 specialized revenue accruals 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 a recurring 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 16 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 expense, in contrast, is a liability with an uncertain timing or amount, but where the uncertainty is not significant enough to qualify it as aprovision. An example is a pending obligation to pay for goods or services received from a counterpart, while cash is to be paid out in a latter accounting period when the amount is deducted from accrued expenses.
In the United States of America, this difference is best summarized by IAS 37 which states:
"11 Provisions can be distinguished from other liabilities such as trade payables and accruals because there is uncertainty about the timing or amount of the future expenditure required in settlement. By contrast:
"(a) trade payables are liabilities to pay for goods or services that have been received or supplied and have been invoiced or formally agreed with the supplier; and
"(b) accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.
"Accruals are often reported as part of trade and other payables, whereas provisions are reported separately."
To add to the confusion, some legalistic accounting systems take a simplistic view of “’accrued revenue”’ and “’accrued expenses”’, defining each as revenue / expense that has not been formally invoiced. This is primarily due to tax considerations, since the act of issuing an invoice creates, in some countries, taxable revenue, even if the customer does not ultimately pay and the related receivable becomes uncollectable.