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Accruals are expenses incurred, or revenues earned that have an impact on the net Income of the company on the income statement. Accruals are also said to have an effect on the Balance Sheet as they comprise non-cash liabilities and assets.
These accounts include accounts payable, accrued tax liabilities, accounts receivable, and accrued interest payable or earned amongst others.
Deferrals and accruals are the foundation of the accrual accounting method. Using the accrual methodology, an Accountant gets to make alterations for revenue that was earned but not recorded in the General Ledger. And, it covers the expenses that were incurred but not recorded.
At the end of every Accounting period, accruals are made by adjusting journal entries so that the reported financial statements can include these amounts. The accrual accounts use greatly enhances the information quality on the financial statement.
Before the accrual use, accountants record only cash transactions. By recording these accruals, a firm can evaluate what it has to pay in the short-term and the revenue that it is expecting to receive. It also enables a company to record assets that don’t have a cash value.
Let’s assume there is an electricity company. The company provided electricity service to customers in December. However, the company didn’t bill the customers until the next month upon the reading of meters.
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To have an accurate revenue figure for the year on the financial statements, the company has to complete the adjusting journal entry for revenue reporting that the company earned in December. It additionally gets reflected in the Receivables account according to December 31 as the company has fulfilled the Obligation to customers in earning the revenue.
The December’s adjusting journal entry may include a credit to the revenue account and a debit to accounts receivable. In the consecutive month, when the company receives the cash, they record the credit to lessen the accounts receivable and a debit to increase the cash.
Another expense accrual takes place for interest. For instance, a company with a bond accrues interest expense on the monthly financial statements, despite the fact that the Bonds’ interest gets paid semi-annually. The interest expense recorded in the adjusting journal entry is going to be the amount that got accrued as per the financial statement date.