In accounting, an accrual is a cost the business has incurred in a period but has not yet been invoiced for or paid, recorded as a liability at the period end. The wider accrual basis (or accruals basis) means recording income when it is earned and costs when they are incurred, regardless of when cash is received or paid. UK company accounts must follow it: the law says all income and charges for the financial year "must be taken into account, without regard to the date of receipt or payment".
The two meanings of "accrual"
- An accrual (the balance). A specific year-end adjustment for an expense already incurred but not yet billed, such as electricity used in March that is invoiced in April. It is a liability, and the statutory balance sheet formats give it its own heading, "Accruals and deferred income";
- The accrual basis (the principle). The overall method of preparing accounts, as opposed to the cash basis. Accruals, prepayments, accrued income and deferred income are all tools for applying it.
So "accruals" in a trial balance means the balances, while "accounts prepared on an accruals basis" means the method.
Where the rule comes from
For companies, the accruals principle is a legal requirement. Paragraph 14 of Schedule 1 to both the Small Companies and Groups (Accounts and Directors' Report) Regulations 2008 and the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008 states: "All income and charges relating to the financial year to which the accounts relate must be taken into account, without regard to the date of receipt or payment."
Tax follows the accounts. A company's trading profits "must be calculated in accordance with generally accepted accounting practice", subject to tax adjustments, which in practice means the accruals basis. Unincorporated businesses are different: for sole traders and partnerships without corporate partners, HMRC describes the cash basis as "the standard way to record your income and expenses", and traditional accruals accounting is an option. Limited companies, LLPs and partnerships with a corporate partner cannot use the cash basis.
Accruals, prepayments and their income equivalents
| Item | What has happened | Balance sheet |
|---|---|---|
| Accrued expense (accrual) | Cost incurred, not yet invoiced or paid | Liability |
| Prepayment | Cost paid in advance for a future period | Asset |
| Accrued income | Income earned, not yet invoiced | Asset |
| Deferred income | Cash received or invoice issued for work not yet done | Liability |
All four move income or costs into the period they belong to. An accrual and a prepayment are mirror images on the cost side; accrued income and deferred income are the equivalents for sales.
Worked example: accruing an expense
A company has a year end of 31 March 2027. Its March electricity, estimated at £600, is not invoiced until 20 April 2027. Without an accrual, March's cost would land in the following year's accounts.
- At 31 March 2027. Debit electricity expense £600, credit accruals £600. The cost is in the right year and a £600 liability shows on the balance sheet;
- On 1 April 2027. The entry is reversed: debit accruals £600, credit electricity expense £600;
- When the invoice arrives. The actual invoice, say £620, is posted as normal. The reversal and the invoice net to £20 in the new year, the difference between the estimate and the bill.
For tax, the £600 is deducted in the year to 31 March 2027 rather than the year after. For a company paying the 19% small profits rate, that brings £114 of relief forward by a year. The same logic applies to accrued income: work completed in March but invoiced in April is income of the March year, and is taxed in that year.
The tax exception for unpaid pay
One accrual needs particular care. If a company accrues employees' or directors' remuneration, typically a year-end bonus, the deduction is only allowed in that period if the remuneration is paid within 9 months of the end of the period of account. If it is paid later, the deduction moves to the period in which it is paid; if it is never paid, there is no deduction at all. The same rule applies to sole traders and partnerships using accruals accounting.
Common mistakes
- Forgetting to reverse. The cost then hits the accounts twice, once as the accrual and again when the invoice is posted;
- Accruing without evidence. An accrual should be based on a contract, usage data or a supplier quote, not a round-number guess;
- Accruing future costs. An accrual is for costs already incurred. Next year's budgeted spending is not an accrual;
- Treating accruals as optional for a company. They are part of preparing accounts that comply with the Companies Act.
Primary sources: Schedule 1, paragraph 14 of the Small Companies Regulations 2008 and the Large and Medium-sized Companies Regulations 2008, CTA 2009 s46 and s1288, ITTOIA 2005 s36, and HMRC's cash basis guidance. For how timing differs from cash, see our guide to cash flow.
If your year-end accruals and prepayments need a second pair of eyes, our statutory accounts team prepares them as part of the year-end, and our management accounts service applies the same adjustments monthly.