Accruals Explained

An accrual is an accounting adjustment made for costs that a business has incurred but not received a bill for.

Examples of Accruals

Common costs that are accrued include things like:

  • Rent
  • Utility bills like electricity and gas
  • Phone bills
  • Accounting fees
  • Interest costs
  • Freelancer and sub-contractor costs

 Here are some common examples of accruals that you may come across.

Accrual Example 1

It is the 31 December 2017 and the end of the financial year for XYZ Limited.  A commission payment of £5,000 is due to an employee of the business for December 2017 which will be paid as part of January 2018 payroll.  XYZ Limited must accrue an amount of £5,000 in respect of commissions payable in the accounts to 31 December 2017.

Accrual Example 2

It is 31 March and an invoice for £7,500 for March rent has still yet to be received from the businesses landlord.  We know that this is an oversight on the landlords part and that an invoice is due from them therefore it is prudent to accrue for the rent for March of £7,500.

Accrual Example 3

It is the 30 April and you are preparing the management accounts for a small business.  You know that a freelance consultant worked for the business during the month of April but has not submitted their invoice.  You should make a reasonable estimate of the accrual and include a provision for the cost of the consultant.

Accrual Example 4

You are in the process of finalising your year end accounts and your accountant will bill for this once the accounts are processed and corporation tax return submitted.  In the year end accounts your accountant will accrue an amount for their fees in order to reflect the cost in the correct financial year.

Why are Accruals Necessary

One of the concepts underlying accounting is ‘Matching‘ – matching revenue with all the related costs for a specified period. It is this concept of matching upon which accruals is based.

Example of the Matching Concept in Accounting:

ABC Limited sells computers on eBay.  During the financial year end 31 December 2017 ABC Limited has sold 100 computers at £500 each and it bought each of the computers in at a cost of £300 each. Its profit and loss account for the year looks like this.

Turnover £50,000£500 x 100 computers
Costs-£30,000£300 x 100 computers
Profit £20,000

Profit for the year is accurately stated because we can see that 100 computers were bought and sold.

Lets suppose ABC Limited’s supplier was late sending in their invoice for 2 of the computers sold to ABC and this was received after the year end on 5 January 2018 for £600.

100 computers were still sold during the financial year to 31 December 2017 but the accounting principle of matching must still be followed as the true costs are still £30,000.  Therefore an accrual needs to be made for the missing invoice.

Bookkeeping Entries for an Accrual Example 1

It is the 31 December 2017 and the end of the financial year for XYZ Limited. 

A consultant has worked for the Company but not yet invoiced for their time. 

The time spent amounts to £5,000 and will be invoiced in January 2018. 

XYZ Limited must accrue an amount of £5,000 in respect of the consultant in the accounts to 31 December 2017.

The bookkeeping entry for the accrual dated 31 December 2017 would be:

Dr Consultants (P&L) £5,000
Cr Accruals (Balance Sheet) £5,000

Once the consultant sends their invoice in January, the accrual should be reversed that way the cost is only included once in the profit and loss account.

The bookkeeping entry would be:

Dr Accruals (Balance Sheet) £5,000
Cr Consultants (P&L) £5,000

Bookkeeping Entries for an Accrual Example 2

It is 31 March and an invoice for £7,500 for March rent has still yet to be received from the businesses landlord. 

We know that this is an oversight on the landlords part, therefore it is prudent to accrue for the rent for March of £7,500.

The bookkeeping entry for the accrual would be:

Dr Rent (P&L) £7,500
Cr Accruals (Balance Sheet) £7,500

Upon receipt of the invoice from the landlord, the accrual can then be reversed.

This would be the bookkeeping entry:

Dr Accruals (Balance Sheet) £7,500
Cr Rent (P&L) £7,500

Should You Include VAT in Your Bookkeeping Entry for an Accrual?

If you are registered for VAT, your accruals should not include VAT.

This is because VAT is not actually a cost for a VAT registered business.

Updated 16 April 2019

About Anita Forrest

Anita Forrest is a Chartered Accountant, spreadsheet geek, money nerd and creator of www.goselfemployed.co - the UK small business finance blog for the self-employed community. Here she shares simple, straight-forward guides to make self-employment topics like taxes, bookkeeping and banking easy to understand.