Accrual Concept in Accounting: Meaning, Importance and Example

Accruals within a business are significant processes that help ensure the company's financial statements properly reflect its financial health. Following the accrual concept means transactions are recorded even if payments for certain services have not been fully paid.

In this article, we will give you a detailed analysis of the accrual concept in accounting, its importance, examples and journal entries and how it differs from the matching concept.

What is the Accrual Concept?

The concept of accrual is the recording of expenses or revenue that has been incurred or earned but still has not been recorded in the financial statements of the business. Accruals in the business can include different transactions, such as expenses incurred but not yet paid or unpaid invoices for any services provided.

What is the Accrual Concept In Accounting?

In accounting, the accrual concept is understood as journal entries, helpful at recognising expenses and revenues that are consumed or earned, respectively. In this case, cash amounts are either not fully paid out or received by the firm.

The accrual concept in business is important, especially while creating financial statements as per the accrual basis of accounting. Within the double-entry bookkeeping process, any accrued expense is considered the liability of the firm and accrued revenue is considered business assets. 

Importance of Accrual Concept

Understanding the accrual concept is important for various reasons, especially since it helps in the accurate preparation of financial statements. Here are some points of significance of accrual accounting.

• Assessment of Business Performance

The performance of a business is assessed more accurately due to the application of the accrual concept. This is because accruals are portrayed in financial statements that indicate the financial health of the company. This happens due to the availability of information on accounts payable and receivable. Instant portrayal of where money is coming from and going out is expected in future reports, making performance assessment easy.

• Planning Future Financials

Accrual accounting is important as it is implemented in the business in real time, making it easy for management to have a detailed overview of finances. It also allows the accountants to assess progress from previous financial years and compare it with the present to plan for the future on an appropriate budget.

• Accurate Results

When accrual accounting is implemented in a company, it depicts a more accurate position of business finances. As debts and income of the firm are properly outlined, it helps the company manage its financials per business activity patterns.

• Implementation of the Matching Principle

The accrual method uses the matching principle method, an important factor in business accounting. In this case, expenses and revenues are reported in the same period and are 'matched' to determine profits or losses of that financial period.

Accrual Concept Example

Here are a few examples of accrual accounting methods followed within a business for an accurate business process.

• Sales Accruals

Suppose ABC Company, a service-based organisation, is working on a major project handled by PBC Company. As per conditions, the billing for this project will only be done after its completion. However, while working on the project, ABC Company can accrue earnings or revenue for the work that is completed to date, even though billing for the project is not issued by PBC Company. This is considered to be revenue accruals of ABC Company.

• Wages Accruals

Consider a scenario where an employer pays wages to its employees on the 20th day of the month for the hours they worked. In such a case, employers can accrue any additional wages earned from 21st day to the end of the month, ensuring full amount of expense on wages gets recorded in financial statements.

• Interest Accruals

For instance, a lender issues a specific amount of loan to a company and sends an invoice every month to the borrower with details of interest owed. The borrower, in such cases, can record interest expense in advance for the receipts, thus specifying its accrued interest.

Accrual Concept Journal Entry

The journal entry aspect for accruals in a business is based on two main rules. They are - 

• Accrued expenses are debited.
• Accrued liabilities are credited.

Let us consider a few examples to fully understand journal entries for accruals in a business.

Suppose K Ltd. sells goods on credit to T Ltd. at an amount of Rs. 5,000. Hence, the journal entry will be - 

Here is another example to understand journal entries.

On January 1, 2023, KBC Ltd. invested Rs.1,000 in a 5-year FD at 5%. It will get the whole amount upon maturity, which will be on December 31, 2028, although interest will be recognised annually. Therefore, the journal entry for this is -