Put simply, an accrual is an accounting adjustment made for costs that a business has incurred but not received a bill for. Read on to find out more about the meaning of accruals, see some examples of them and understand why they matter when it comes to producing financial statements.
What is an Accrual and What Does it Mean?
When running a business, costs are sometimes incurred even though a supplier has not sent an invoice. These types of costs are accrued using an accounting adjustment to show the cost and liability in the accounts.
Examples of Accruals
Common costs that are accrued include:
- Utility bills like electricity and gas
- Phone bills
- Accounting fees
- Interest costs
- Freelancer and
sub-contra c torcosts
Here are some common examples of accruals that you may come across.
Do Accruals Include VAT?
If a business is registered for VAT, then accruals should not include VAT because it is not a cost to the business. However, if the business is not registered for VAT, then accruals should include VAT.
It is the 31 December 2023 and the end of the financial year for Eddie Limited. A commission payment of £5,000 is due to an employee of the business for December 2023 which will be paid as part of January 2024 payroll. Eddie Limited must accrue an amount of £5,000 in respect of commissions payable in the accounts to 31 December 2023.
It is 31 March and the landlord has yet to send an invoice for £7,500 for rent due from 1 March 2024 to 31 March 2024. Since this is an oversight on the landlord’s part and an invoice is expected, it is prudent to accrue the rent for March of £7,500.
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.
Why Accruals Are Important?
Accruals ensure that all the costs of the business have been included in the financial statements, providing an accurate picture of its profit or loss for the accounting period. It is part of the matching concept in accounting – that revenue must be matched with all the related costs for the specified accounting period.
Double-Entry For An Accrual
The bookkeeping entry for an accrual is: Dr Cost (Profit and Loss Account) Cr Accrual (Balance Sheet)
Using example 2 above for the missing rent invoice, the double entry for the rent accrual would be:
|Dr Rent (P&L)||£7,500|
|Cr Accruals (Balance Sheet)||£7,500|
Once the landlord sends the invoice, it can be recorded as a trade creditor and the accrual can then be reversed.
This would be the bookkeeping entry:
|Dr Accruals (Balance Sheet)||£7,500|
|Cr Rent (P&L)||£7,500|