Adjusting entries: accrued expenses and revenue

An accrual arises when the expense is incurred or the revenue earned before cash moves or an invoice arrives. Nothing has been recorded yet — no document has passed through the books — so without an adjusting entry the cost or income would simply be missing from the period it belongs to.

• Accrued expenses: staff have worked days that will be paid next period; interest has built up on a loan; electricity has been used but not yet billed; this year's audit will be billed next year. Debit the expense, credit a liability (Accrued expenses, Salaries payable, Interest payable).
• Accrued revenue: work done but not yet invoiced. Debit a receivable (or a contract asset, if the right to payment still depends on further performance), credit revenue.

Measuring the amount. Accruals are measured from evidence, not guessed: - Salaries: days worked since the last payday × daily cost. Count only days up to the period end. - Interest: principal × annual rate × fraction of the year since interest was last paid. Interest accrues with time whether or not a payment is due. A 24,000 loan at 6% a year costs 1,440 a year, or 120 a month. - Utilities: a meter reading or a time-apportioned estimate from past bills. - Unbilled work: hours or milestones delivered × the agreed rate.

Settling an accrual. When the bill or payday arrives next period, the payment first clears the liability; only the part that relates to the new period is expense. Forgetting this double-counts the cost — once when accrued and again when paid. (Reversing entries, the next lesson, are one way to avoid that.)

What is not an accrual. A purchase order for goods arriving next month, or next month's rent, is not yet an obligation: the other party hasn't performed. Accrue for goods and services received, not ordered.

Missing accruals usually overstate profit (expenses are left out) and understate liabilities — which is why auditors test them closely at the year end.