Accrual income is reported as gross income when:
A business receives a payment Income is due to be paid to a business When a business earns revenueIf a title (on the property) is passed on to the business as part of a transaction
In contrast, an accountant or bookkeeper can defer accrued expenses when:
Services or property are provided to clients The business has recovered a liability
Example of Accrued Revenue
Accrued revenue is income that’s earned by the business but has yet to be billed to or received from the client or customer. An example of accrual of revenues would be a contractor completing a job for a homeowner. Throughout December, the contractor is completing work for their client. However, the contractor does not send an invoice until all work has been completed. The client would receive their bill in January. The contractor adjusts its financial statement so that:
Income for December and the new year will be reported as earned by the contractorThe Dec. 31 balance sheet will include the income the contractor should expect to receive from all clients.
Example of Accrued Expense
An accrued expense refers to any liabilities, losses, or ongoing accounts payable that have not yet been recorded. An example of an accrued expense would be a landlord of a large building replacing the boiler in December—the last month of an accounting year. However, the company, or tenant, will not pay the bill until an invoice is received in January. Using the accrual method, a bookkeeper or accountant must:
Record the liability or expense on the balance sheet in the previous year. Report the repair and its expense on the income statement for the current year.
A business’s expenses can include any costs related to running the company such as rent, utilities, office supplies, property, equipment, and payroll.
How Accruals Work
In the accrual method of accounting, businesses will report income in the year it is earned, while expenses will also be recorded in the year they were incurred. The purpose of accruals is to ensure that businesses match their income and expenses accurately within an accounting year.
Tax Implications
In terms of taxes, accrual accounting requires companies to pay taxes on income that is still owed, meaning you generally report income in the tax year you earn it, regardless of when payment is received. The same goes for expenses, which you deduct in the tax year you incur them, regardless of when payment is made. Small businesses such as microbusinesses and sole proprietorships that file individual taxes and likely earn less revenue than corporations and partnerships do not have to use accrual accounting to manage their finances. Under the 2017 Tax Cuts and Jobs Act, the IRS allows small businesses generating less than $25 million in annual gross receipts from the three previous tax years that are not in a tax shelter to opt for cash accounting instead of accrual. While accrual accounting may be considered a more complex method than cash accounting, it can provide bookkeepers and accountants with a more accurate long-term view of a business’s finances.
