Accountants and bookkeepers are more than familiar with the term accrual. To get a firm grasp of it, here is everything you need to know about what an accrual is.
In business, an “accrual of something” refers to any adjustments made to the company’s finances before issuing its financial statement. It refers to any financial transaction made that has yet to be recorded in the company’s accounts. Such undertakings include:
- Asset or revenue earned but has not been reported in the books.
- Expenses, liabilities, and losses incurred that have not been recorded yet.
How Does An Accrual Work?
Earnings made or expenses incurred profoundly influence a company’s financial statement, even if the money related to the transaction has yet to change hands. It also affects a firm’s current assets and liabilities, thus influencing its balance sheet’s bottom line.
For example, a water utility company supplied water to all its consumers for December. However, they will not bill them immediately. Billing would come at consumers’ doorstep when a meter reading is made, not until the following month.
This transaction occurred at the end of the financial year, thus making adjustments necessary to keep the company’s financial statements accurate. For a proper revenue report, the enterprise needs to adjust its journal entry—recordings of unrecognized income and expenses made at the end of a firm’s accounting period.
Once an accrual is made, it will then reflect on the enterprise’s receivables account on December 31. Since the company already fulfilled its obligation to its consumers, the accrued revenue is now included in this accounting period’s financial statement report.
Why Are Accruals Important?
Accruals are relevant for several reasons.
- It gives information on relevant business transactions such as credits and future liabilities.
- Shows and records short-term debts and the future revenue to be received.
- Provide a fundamental standpoint of the company’s performance and finances.
- It helps in making financial decisions since there are no hidden and unrecognized transactions.
What Is Accrual Accounting?
Companies use two standard accounting methods to keep their books in check—accrual and cash basis. The accounting method a firm chooses depends on its sales volume, credit sales, and company structure.
Most enterprises, except startups and small businesses, use an accrual accounting system for its accuracy in gauging the firm’s current condition. It also gives top-quality information and analyses of your financial statements.
It might be more expensive and sophisticated than a cash basis, but it simplifies the complicated business transactions within the company.
The principle of accruals and deferrals serves as the basis of the accrual accounting method. The technique accounts for all transactions as they occur, even if the money has not entered their account yet.
Sales are entered into the system once invoices are generated rather than when money is collected. The same goes for accrued expenses of the firm.
The only downside is the tax the company has to pay in advance. Still, it is an ideal basis for business owners, associates, and investors when navigating the financials of their organization.
An accounting firm is a good resource for managing your finances. Annette Ferguson – Chartered Accountant and Certified Profit First Professional – can help you unlock financial strategies to improve the profitability of your business amidst an economic crisis. Book a call with us. You can also follow us on any of our social media channels and subscribe to our YouTube channel.