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Accruals: What They Are, Why They Matter, and How to Use Them in the Monthly Close

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Accruals are one of the most important—and most misunderstood—parts of accounting. They are essential to producing accurate financial statements, especially for businesses that need to understand their true performance month-over-month.

While the word "accrual" might sound like confusing accountant jargon, the concept is actually very simple: it's about matching revenue and expenses to the time period where they actually happened, regardless of when the cash changed hands.

Overview

Use this guide to define accruals and place them correctly in the monthly close.

This guide explains what accruals are in plain English, why they exist, common real-world examples that business owners face every day, how they fit into the monthly close process, and practical considerations for tax and financial reporting.

What Is an Accrual?

An accrual is simply an accounting entry used to record revenue or expenses when they are earned or incurred, even if cash has not yet been received or paid.

The core question an accrual answers is: "What activity actually belongs in this month?"

If you only look at your bank account (cash basis), you might think you had a very profitable month just because you didn't pay any bills yet. But that's not true profit; that's just timing. Accruals fix this by recording the expense now because you used the service now, even if the bill comes later.

They allow financial statements to reflect economic reality rather than just cash flow timing.

Real-World Timing Examples

To understand accruals, let's look at three common scenarios where cash timing and economic reality don't match.

Example 1: The Late Electricity Bill (Accrued Expense)

Imagine your business runs a factory. In December, you run the machines 24/7 to meet holiday demand. You use a massive amount of electricity. However, the electric company doesn't read the meter until January 2nd, and they don't send you the bill until January 15th.

Without an accrual (Cash Basis): Your December books show $0 for electricity expense. Your January books show a huge bill. This makes December look artificially profitable and January look like a disaster.
With an accrual: You estimate the cost of the electricity you used in December (say, $5,000) and record it as an expense in December. Now, December's profit reflects the true cost of earning that holiday revenue.

Example 2: Payroll Spanning Two Months (Accrued Payroll)

Your employees are paid every two weeks. The pay period ends on Friday, January 4th. This paycheck covers work done from December 22nd through January 4th.

Without an accrual: The entire payroll expense hits your books in January when the checks are cut.
With an accrual: You calculate how much of that payroll was earned by employees in December (the days from Dec 22-31). You record that portion as a December expense. The remainder (Jan 1-4) is recorded in January. This ensures that December's labor costs match December's sales.

Example 3: The Big Consulting Project (Accrued Revenue)

You are a consultant working on a 3-month project. You do a significant amount of work in January, delivering a key milestone. However, the contract says you can only bill the client at the end of the project in March.

Without an accrual: You show $0 revenue in January and February, and a huge lump sum in March. It looks like you did nothing for two months and then had a record-breaking March.
With an accrual: You recognize revenue in January based on the work you actually completed (percentage of completion). Your financial statements show steady revenue that matches your effort.

Why Accruals Matter

Without accruals, your financial statements are at the mercy of the mailbox. If a bill arrives a day late, your profit changes.

Expenses: May appear too low one month and too high the next.
Revenue: May be bunched up in months when invoices are sent, rather than when value is created.
Profitability: Becomes volatile and misleading. You can't compare January to February if the costs are lumped randomly.

Accruals support the matching principle, a fundamental accounting rule. It says that you must match the revenue you earned with the expenses you used to generate it. If you sold a widget in January, the cost of that widget (and the electricity to make it, and the sales commission) should also be in January.

Accruals vs Cash Transactions

Scenario	Cash Basis (When money moves)	Accrual Basis (When activity happens)
Expense incurred, not yet paid	Not recorded yet.	Dr Expense / Cr Accrued Liability
Revenue earned, not yet billed	Not recorded yet.	Dr Accrued Revenue / Cr Revenue
Cash paid later	Expense recorded now.	Dr Accrued Liability / Cr Cash
Cash received later	Revenue recorded now.	Dr Cash / Cr Accrued Revenue

Accruals separate the timing of the activity from the timing of the cash.

Common Types of Accruals

There are several standard accruals that almost every business will encounter. Here is a deeper look at them.

Accrued Expenses

These are liabilities for goods or services you have received but haven't paid for. This is the most common type of accrual. It captures everything from the utility bill mentioned above to legal fees for a case currently in progress.

Typical Entry: Debit the Expense account (increasing cost) and Credit Accrued Liabilities (increasing what you owe).

Common Examples:

Professional Fees: Your accountant worked on your taxes in December but won't bill you until February.
Interest: You have a loan. Interest accumulates every day, but the bank only charges you once a month. You must accrue the interest daily or weekly to be accurate.
Commissions: Your sales team closed deals in December, but you pay commissions in January. You must accrue the commission expense in December.

Accrued Payroll

This is specific to labor. Since people are paid in arrears (after they work), there is almost always a few days of "unpaid" work at the end of every month. Accruing this ensures that your biggest expense—labor—is reported in the correct month.

Why it's critical: If you have 50 employees, 3 days of payroll can be tens of thousands of dollars. Missing this accrual can significantly overstate your profit.

Accrued Revenue

This is an asset. It represents money you have earned but haven't invoiced yet. This is common in service industries (lawyers, accountants, construction) where billing happens in cycles or at milestones.

Typical Entry: Debit Unbilled Revenue (an asset like Accounts Receivable) and Credit Revenue (increasing sales).

Why it's critical: If you don't accrue revenue, your sales team might look like they are underperforming when they are actually working hard.

Prepaid Expenses (The Flip Side)

While technically a "deferral" rather than an accrual, prepaids deal with the same problem in reverse: Cash is paid before the expense is incurred.

Example: You pay $12,000 in January for a full year of insurance.
Accounting: You don't expense $12,000 in January. You record it as an asset ("Prepaid Insurance") and then expense $1,000 each month for 12 months.

Accruals in the Monthly Close Process

Accruals typically happen near the end of the monthly close. Why? because you need to know what transactions didn't happen naturally before you can fix them with accruals.

A common workflow:

Record routine transactions: Enter all bills and invoices you have.
Reconcile bank accounts: Make sure cash is correct.
Review open purchase orders or time sheets: Identify what is missing. "Hey, did we get the invoice from the cleaning crew yet?"
Record accrual entries: Post the journal entries to fill the gaps.
Review financial statements: Does the gross margin look right? Does payroll look consistent?
Close the period: Lock the books.

Reversing Accruals

Here is a critical mechanical step: Many accruals are temporary.

If you accrue $500 for electricity in December, and then the actual bill for $510 comes and is paid in January, you have a problem. You don't want to record the expense twice (once in the accrual, once in the bill payment).

To solve this, we use reversing entries. On the first day of the new month (January 1st), you reverse the accrual entry.

Jan 1: Debit Accrued Liability / Credit Expense.

Now, when the real bill comes in January, you record it normally. The reversal cancels out the "duplicate" expense in January, leaving the net expense in December where it belongs.

Judgment and Consistency Matter

Accruals are not always precise. They often involve estimates. You might not know the exact electricity bill, so you use the average of the last three months. That is okay.

Key questions to ask:

Is it material? If the missing bill is for $20, it probably doesn't matter. If it's for $20,000, it definitely matters.
Can it be reasonably estimated? Do you have a contract or past history to base the number on?
Is it consistent? If you accrue for something one month, you should probably do it every month.

It is better to be consistently slightly off than to be randomly right or wrong.

Common Accrual Mistakes

Errors in accrual accounting can distort your financial picture significantly. Here are some pitfalls to avoid:

Forgetting to reverse accruals: This is the most common error. If you accrue an expense in December and forget to reverse it in January, you will double-count the expense when the actual bill is paid. This makes January look worse than it is.
Accruing immaterial items: Don't waste time accruing a $15 office supply purchase. Focus on the big items that actually move the needle on your financial statements.
Accruing estimates without documentation: Always save your work. If you estimated a $10,000 legal bill, attach the email from the lawyer or your calculation spreadsheet to the journal entry.
Treating accruals as permanent balances: Accrual accounts (like "Accrued Liabilities") should generally clear out or change significantly every month. If the balance stays the same for six months, you probably forgot to reverse something.
Mixing accrual logic into cash-basis tax books: If you keep your books on a cash basis for tax simplicity but try to add "some" accruals for management, be very careful. You might end up with a hybrid mess that is useless for both purposes.

Accruals should clarify financials, not complicate them.

Tax Considerations

Accruals affect your financial reports, but your tax return might be different.

Many small businesses file taxes on a Cash Basis (because it's simpler and delays tax on unpaid invoices), even if they use Accrual Basis for their internal management reports.
Some accruals (like estimated warranty costs) might not be deductible for tax purposes until the money is actually spent.

This difference is normal. Your accountant will make "Book to Tax" adjustments at the end of the year. The goal of monthly accruals is to give you the business owner clear data to run the company, not necessarily to perfectly match the tax return every month.

Best Practices for Managing Accruals

Use a checklist: Don't rely on memory. Have a list of standard accruals (Payroll, Rent, Utilities, Commissions) to check every month.
Document your math: Keep a spreadsheet showing how you calculated the accrual. If you estimated $5,000, write down "Based on avg of last 3 months."
Review outcomes: If you accrued $5,000 and the bill came in at $8,000, adjust your estimate for next time.
Auto-reverse: Set your accounting software to automatically reverse accrual journals on the first of the next month. This prevents double-counting errors.

Final Thoughts

Accruals are what turn bookkeeping into true accounting. They take the raw data of cash movements and smooth them out into a clear picture of business performance.

They help you answer: "Did we actually make money this month?" rather than just "Did our bank balance go up?"

Used thoughtfully, accruals strengthen your financial reporting. Used casually, they can distort it. Start with the big items—payroll and major expenses—and refine from there.

Need help setting up or reviewing accruals as part of your monthly close? BookkeeperGroup helps businesses design clean, consistent accrual processes that support accurate reporting without unnecessary complexity.

Next steps

See monthly accrual checklist
See example journal entries
See reversing-entries workflow
See accruals vs prepaids deep dive
See cash-basis businesses using accrual reporting

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