An accrual is an amount recognized in the period it is earned or incurred, ahead of the cash, and the balance that recognition leaves on the balance sheet until the cash settles. Accruals run in two directions: revenue earned and not yet billed or collected leaves an asset behind, and a cost incurred and not yet invoiced or paid leaves a liability.
The FASB’s conceptual framework defines the item by the balance it creates rather than by the paperwork behind it. Accrual is the accounting process of recognizing assets or liabilities and the related changes in revenues, expenses, gains, losses, or equity for amounts expected to be received or paid, usually in cash, in the future (FASB Statement of Financial Accounting Concepts No. 8, Chapter 1 (As Amended)). Assets and liabilities come first in that sentence and the revenue or expense follows them.
The same word also names the method of accounting the item belongs to. A book accrual can be right on the ledger and still premature on the return, because the deduction side adds an economic performance test on top of the all events test. The method, both of its timing tests and the position a taxpayer states on the return are set out in accrual accounting.
Where Accruals Sit on the Balance Sheet
Both directions leave a balance, and the two land on opposite sides of it.
Accrued Revenue, the Asset Side
Work delivered before an invoice goes out is income the period has earned and an asset the business owns. Where receivables include amounts due under long-term contracts, a balance sheet filed under Regulation S-X states separately the amounts representing the recognized sales value of performance and such amounts that had not been billed and were not billable to customers at the date of the balance sheet, with a general description of the prerequisites for billing (17 CFR 210.5-02). Unbilled is a presentation question there, not a reason the earned amount is missing.
Whether an unbilled amount is a receivable or a contract asset turns on whether the right to payment has become unconditional, which is set out in accounts receivable. Accrued revenue and accrued interest receivable both sit on this side, one built on work delivered and one on money lent or owed across time.
Accrued Expenses, the Liability Side
A cost incurred with no invoice behind it is a liability the business owes and has not been billed for. On a balance sheet filed under Regulation S-X, accrued payrolls, accrued interest and taxes are named among the items that may sit under other current liabilities, with any item in excess of 5 percent of total current liabilities stated separately in the balance sheet or in a note and the remainder shown in one amount (17 CFR 210.5-02). The evidence test that separates an accrued expense from a trade payable, a document the supplier sent against the business’s own estimate, is set out in accounts payable.
Accrued interest appears on both sides of the balance sheet, as accrued interest payable here and as the accrued interest receivable that sits with the assets.
The Accrual That Turns on Probability, Not an Invoice
An ordinary accrual rests on something that has already happened. The work was delivered or the service was received, and only the amount is an estimate. Amounts owed for services received, such as advertising and utilities, are not contingencies even though the accrued amounts may have been estimated, because there is nothing uncertain about the fact that those obligations have been incurred (FASB Statement of Financial Accounting Standards No. 5, paragraph 2).
A loss contingency is the case where the event itself is uncertain, and it carries a different condition. An estimated loss from a loss contingency shall be accrued by a charge to income if both of the following conditions are met: information available prior to issuance of the financial statements indicates that it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and the amount of loss can be reasonably estimated (the same statement, paragraph 8).
Probable carries a defined meaning there rather than a colloquial one: the future event or events are likely to occur (the same statement, paragraph 3).
Where either condition is not met, the route is disclosure rather than an entry, and only where the loss is at least reasonably possible. Disclosure of the contingency shall be made when there is at least a reasonable possibility that a loss or an additional loss may have been incurred (the same statement, paragraph 10). A chance the standard calls remote, meaning the chance of the future event or events occurring is slight, requires neither (the same statement, paragraph 3).
Statement No. 5 has itself been superseded. On the effective date of Statement No. 168 all then-existing non-SEC accounting and reporting standards were superseded except as that Statement noted, and the Codification became the source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities (FASB Statement of Financial Accounting Standards No. 168, paragraph 15).
Where the Entry Enters the Close
An accrual is an adjusting entry, posted at period end after the period’s ordinary transactions are recorded and before the statements come out.
An accrual is commonly reversed as well. A reversing entry posted at the start of the next period backs the accrual out, so the real invoice can be coded and posted in full when it arrives without anyone checking whether part of it is already sitting in the ledger. The alternative is to leave the accrual standing and post only the difference against it, which works but puts the burden on whoever opens the invoice to remember. Where these entries fall in the sequence is set out in the month-end close checklist.
A Worked Example
Say a firm’s IT support vendor bills a month in arrears, so the December invoice does not arrive until the middle of January. The firm accrues its best estimate at the December year end, reverses that entry at the start of January, and posts the invoice when it lands.
Accrued at the December year end for December support 3,200
Reversing entry posted at the start of January (3,200)
Supplier invoice received and posted in January 3,450
Net support cost left in January 250December carries the estimate, January carries only the amount by which the invoice exceeded the estimate, and the two months together carry the invoice in full. Without the reversal, an invoice coded straight to expense would land on top of a liability nobody cleared, and the cost would sit in the books twice until someone found it.
What an Accrual Is Not
A Deferral
A deferral runs the other way. The cash has already moved, or the invoice has already gone out, and recognition is held back until the period the amount belongs to, so a deferral parks a liability for money taken early or an asset for money paid early. Both of its directions are set out in deferral.
An Allocation
Accrual accounting includes using accrual, deferral, and allocation procedures, so an accrual is one of three things the method does. Allocation is the accounting process of assigning or distributing an amount according to a plan or a formula, and its examples include spreading the cost of an insurance policy or a building across two or more accounting periods (FASB Statement of Financial Accounting Concepts No. 8, Chapter 1 (As Amended)). Depreciation spreads a cost already incurred, so calling it an accrual misdescribes what the entry is doing.
Common Questions
At work the word usually means leave rather than ledgers. A paid time off accrual is the balance an employee has earned under the employer’s policy and has not yet taken, and it builds up as service is rendered rather than when the time is used or paid out.
That balance can be an accrual in the accounting sense too. An employer shall accrue a liability for employees’ compensation for future absences if all of these conditions are met: the obligation relating to employees’ rights to receive compensation for future absences is attributable to employees’ services already rendered, the obligation relates to rights that vest or accumulate, payment of the compensation is probable, and the amount can be reasonably estimated (FASB Statement of Financial Accounting Standards No. 43, paragraph 6). An employer is not required to accrue a liability for nonvesting accumulating rights to receive sick pay benefits (the same statement, paragraph 7), so an accumulating sick balance that never vests can sit outside that liability. That Statement was superseded on the effective date of Statement No. 168 as well (FASB Statement of Financial Accounting Standards No. 168, paragraph 15).
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can put its own period-end accrual and reversal schedules through a trial task before its own reviewer relies on them.
