Accruals are amounts recognised in the financial statements for expenses that have been incurred or income that has been earned during an accounting period but have not yet been invoiced or paid. They are a direct application of the accruals concept (also called the matching principle), which requires that income and expenses are recognised in the period to which they relate, regardless of when cash changes hands.
The accruals concept is one of the fundamental accounting principles under FRS 102 and the Companies Act 2006, and it underpins the preparation of all UK financial statements prepared on an accruals basis.
The Accruals Concept
Under the accruals basis of accounting, transactions are recorded when they occur, not when the related cash is received or paid. This means:
- Revenue is recognised when goods are delivered or services performed, not when the customer pays
- Expenses are recognised when the cost is incurred, not when the supplier is paid
The alternative is the cash basis, where transactions are only recorded when cash moves. While some very small businesses may use the cash basis for tax purposes (HMRC permits this for businesses with turnover below £150,000), the accruals basis is required for all UK companies and for any business that needs to give a true and fair view of its financial position.
Types of Accruals
Accrued Expenses (Accrued Liabilities)
An accrued expense arises when a cost has been incurred during the period but no invoice has been received or payment made by the reporting date. The expense must still be recognised in the income statement and a corresponding liability recorded on the balance sheet.
Common examples of accrued expenses:
| Expense | Reason for Accrual |
|---|---|
| Utility bills | Consumed but billed in arrears |
| Employee wages | Work performed but payday falls in the next period |
| Interest on loans | Accruing daily but paid periodically |
| Audit and accountancy fees | Service relates to the year but billed afterwards |
| Rent | Rental period straddles the reporting date |
| Professional fees | Legal or consultancy work performed but not yet billed |
Accrued Income (Accrued Revenue)
Accrued income arises when revenue has been earned but not yet invoiced or received. This is less common than accrued expenses but occurs in situations such as:
- Interest earned on deposits but not yet credited by the bank
- Work performed under a long-term contract but not yet billed
- Commission earned but not yet received
- Rental income for a period that straddles the reporting date
Recording Accruals: Journal Entries
Accruing an Expense
A company’s financial year ends on 31 March. The electricity bill for January to March has not yet been received. Based on previous bills, the estimated cost is £900.
31 March (year-end adjusting entry):
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Electricity expense | 900 | |
| Accruals | 900 |
This ensures the expense appears in the correct period’s income statement and the liability appears on the balance sheet.
When the actual invoice arrives in April for £920:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Accruals | 900 | |
| Electricity expense | 20 | |
| Accounts payable | 920 |
The accrual is reversed, and the difference (£20) is charged to the new period.
Accruing Income
A company earns interest of £250 on a fixed deposit for the period ending 31 March, but the bank will not credit the interest until 15 April.
31 March:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Accrued income | 250 | |
| Interest received | 250 |
15 April (when cash is received):
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Bank | 250 | |
| Accrued income | 250 |
For more on how these entries work in the double-entry system, see the guide to journal entries.
Accruals on the Balance Sheet
Accrued expenses are presented within creditors: amounts falling due within one year on the balance sheet, typically combined with deferred income:
| Creditors: amounts falling due within one year | £ |
|---|---|
| Trade creditors | 42,000 |
| Taxation and social security | 15,000 |
| Accruals and deferred income | 11,500 |
| Other creditors | 4,200 |
| Total | 72,700 |
Accrued income appears within debtors as a current asset:
| Debtors | £ |
|---|---|
| Trade debtors | 55,000 |
| Prepayments and accrued income | 6,800 |
| Total | 61,800 |
Accruals Versus Other Items
Understanding how accruals differ from related concepts prevents misclassification:
| Item | Definition | Balance Sheet Classification |
|---|---|---|
| Accrued expense | Cost incurred, not yet invoiced | Current liability |
| Trade payable | Invoiced but not yet paid | Current liability |
| Prepayment | Paid in advance, not yet consumed | Current asset |
| Provision | Liability of uncertain timing or amount | Provision for liabilities |
| Accrued income | Revenue earned, not yet invoiced | Current asset |
The key distinction between an accrual and a trade payable is whether an invoice has been received. Once the invoice arrives, the accrual is replaced by a trade payable.
Common Accruals at Year End
Most UK businesses process a significant number of accruals at the end of their financial year. A typical accruals list might include:
| Item | Estimated Amount (£) |
|---|---|
| Electricity (final quarter) | 1,200 |
| Gas (final quarter) | 800 |
| Audit fee | 5,000 |
| Accountancy fee | 3,000 |
| Employee bonuses | 12,000 |
| Holiday pay accrual | 4,500 |
| Interest on loan | 1,800 |
| Rent (partial month) | 2,000 |
| Total accruals | 30,300 |
Holiday Pay Accrual
Under UK employment law, employees accrue holiday entitlement throughout the year. If employees have untaken holiday at the reporting date, the company must accrue the cost of this entitlement. FRS 102 specifically requires recognition of short-term compensated absences as a liability.
Example: 5 employees have a combined 15 days of untaken holiday. Average daily pay is £120:
Accrual = 15 x £120 = £1,800
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Wages expense | 1,800 | |
| Holiday pay accrual | 1,800 |
Accruals and VAT
Accruals are generally recorded net of VAT because the VAT cannot be reclaimed until the actual invoice is received. Under Making Tax Digital (MTD) rules, input VAT can only be claimed when a valid VAT invoice is held.
However, for output VAT on accrued income, the tax point rules determine when VAT becomes due. If the supply has been made but no invoice issued, the tax point is the date of supply, and output VAT may need to be accounted for.
Accruals and Corporation Tax
For corporation tax purposes, HMRC generally allows accrued expenses as deductible in the period to which they relate, provided:
- The expense has genuinely been incurred
- It is a legitimate business expense
- The amount can be estimated with reasonable accuracy
However, certain accruals have specific tax rules. For example, bonus accruals are only deductible if paid within nine months of the year end. If unpaid after nine months, the deduction is deferred to the period in which payment is made.
The Importance of Accurate Accruals
Accruals directly affect the reported profit or loss for the period. Understating accruals overstates profit, while overstating accruals understates profit. Both scenarios misrepresent the company’s financial position.
Impact on Financial Statements
| Error | Effect on Profit | Effect on Balance Sheet |
|---|---|---|
| Accrual understated | Profit overstated | Liabilities understated |
| Accrual overstated | Profit understated | Liabilities overstated |
| Accrual omitted entirely | Profit overstated | Liabilities understated |
Under the Companies Act 2006, directors have a duty to ensure the accounts give a true and fair view. Materially inaccurate accruals could result in qualified audit opinions and regulatory action.
Accruals in Monthly Management Accounts
While statutory accounts are prepared annually, many UK businesses prepare monthly management accounts for internal decision-making. Accruals play a vital role in ensuring monthly results are meaningful:
- Spreading annual costs (such as insurance or audit fees) evenly across months
- Recognising revenue in the month it is earned
- Matching costs with the revenue they help generate
Without monthly accruals, the management accounts would show erratic profit figures that do not reflect the true underlying performance of the business.
Reversing Accruals
Many businesses use reversing entries at the start of each new period to cancel the previous period’s accruals. When the actual invoice arrives, it is recorded normally without the risk of double-counting.
Reversing entry on 1 April:
| Account | Debit (£) | Credit (£) |
|---|---|---|
| Accruals | 900 | |
| Electricity expense | 900 |
This approach simplifies the bookkeeping process and reduces the risk of errors when processing the actual invoice.
Accruals and Financial Management
Accurate accruals are essential for effective financial management. They enable managers to:
- Understand the true cost of operations in each period
- Make informed decisions based on accurate profit figures
- Maintain creditor relationships by tracking what is owed
- Comply with statutory requirements for financial reporting
- Prepare cash flow forecasts by understanding the timing difference between expense recognition and payment
The discipline of recording accruals correctly sits at the heart of reliable financial reporting under UK GAAP.