Accrue: Definition, How It Works, and the 2 Main Types of Accruals

Key takeaways

• To accrue means to accumulate interest, income, or expenses over time and recognize them in accounting records before cash changes hands.
• The two main accrual types are accrued revenues (income earned but not yet received) and accrued expenses (costs incurred but not yet paid).
• Accrual accounting follows the matching principle and gives a more accurate view of financial performance than cash accounting. GAAP and IFRS require accrual recognition for many entities.

What “accrue” means

Accrue refers to amounts that build up and will be paid or received in a future period. In accounting, accruals record economic events when they occur rather than when cash is exchanged. This ensures revenues and expenses are recognized in the period they relate to.

How the accrual process works

• An accrual entry adjusts accounting records for:
• Revenues earned but not yet received (accrued revenue).
• Expenses incurred but not yet paid (accrued expenses).
• Accruals create or change asset and liability balances—commonly accounts receivable or accrued liabilities—so financial statements reflect obligations and expected inflows.
• Journal entry patterns:
• Accrued revenue: Debit Accounts Receivable, Credit Revenue.
• Accrued expense: Debit Expense, Credit Accrued Liabilities (or Accounts Payable).
• Many organizations use reversing entries at the start of the next period to simplify subsequent cash receipts or payments.

Why accruals matter

• Provide a truer picture of performance by matching revenues with related expenses in the same period (matching principle).
• Prevent understatement of liabilities or overstatement of net income if costs are not recorded when incurred.
• Required or expected under Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) for most companies.
• Cash accounting, by contrast, records only when cash changes hands and can miss credit sales, unpaid obligations, or future cash needs—making it more suitable only for some small businesses.

Main types of accruals

Accrued revenue

Definition: Income earned from goods or services delivered but not yet received in cash.
Examples and implications:
* A company completes work in December but won’t be paid until January. Under accrual accounting, revenue is recorded in December.
* Common in businesses that sell on credit or with milestone billing (projects, services, subscriptions).
* Typical journal entry: Debit Accounts Receivable; Credit Revenue.

Accrued expense

Definition: Costs recognized when incurred but not yet paid.
Common types:
* Interest expense — interest accumulates between invoice dates.
Supplier accruals — goods or services received on credit.
Wages and salaries — employee time earned before the payroll date.
Examples and implications:
* If payroll covers the last days of a month but pay date is in the next month, the employer records the earned wages as an accrued expense for the reporting month to avoid understating operating expenses.
* Typical journal entry: Debit Expense; Credit Accrued Liabilities (or Accounts Payable).

Impact on financial statements

• Balance sheet: Accrued revenues increase receivables (assets); accrued expenses increase liabilities.
• Income statement: Revenue and expense recognition affects reported net income for the period, improving comparability across periods.

Practical considerations

• Accrual accounting requires judgment (estimating amounts and timing) and periodic adjustments.
• Small or very simple businesses may use cash accounting for simplicity, but accruals are generally preferred for accurate financial reporting and are required for larger companies or those following GAAP/IFRS.
• Accurate accruals help with forecasting cash needs, assessing profitability, and meeting regulatory reporting requirements.

Bottom line

Accruing means recognizing income or costs as they are earned or incurred rather than when cash is exchanged. The two primary accruals—accrued revenues and accrued expenses—ensure financial statements reflect the true economic activity of a business. While accrual accounting is more complex than cash accounting, it provides a clearer, more reliable view of financial health and performance.