In accounting, the term accruals refer to those obligations for which a formal demand of payment (i.e., invoice) has not yet been received. This means that you owe someone a payment which you have to pay but that other party has not yet asked for the payment (meaning that invoice has not yet been issued by the vendor).
Or by another definition, this is the expense which has been occurred, but the supplier has not yet raised the invoice. For example, you are consuming electricity every day. But you’ll not receive the electricity bill every day. Let’s assume that you receive the electricity bill on 20th of every month which contains electricity charges up to 15th of that month. Now, this invoice we can book as a liability (debiting electricity expense and crediting utility services provider).
However, for the remaining 15 days of the same month, we will not receive an invoice in the current month or even early next month. Therefore, once we are closing our books of accounts for this month-end, we know that we have consumed electricity for the second half of the month, but we have not yet received the invoice. The invoice will come after 20 days, but this is our expense related to the current month, and therefore we should record this expense and book our liability (as an accrual).
A prudent company would book its expenses of a month (and corresponding payable) by the end of each month-end. This booking will be done even though an invoice is not yet received. A prudent company would assess and estimate its accruals and then make provision for them accordingly.
Following are the general types of transactions for which accruals are recorded:
- Utility bills (electricity, water, telephone, company mobiles etc.)
- Interest expense
- Rental expenses
- Municipality charges
- Audit fees
- Cleaning services
Here it would be a good idea to compare prepayments and accruals. In a prepayment, you make the payment, but that expense has not been incurred and thus payable has also not been recorded. In case of an accrued expense, the expense has been incurred, but payment has not been made, and that payable has not yet been created (because that supplier has not yet sent the invoice).
In most of the organizations, the source document for booking a payable is the supplier’s invoice. A payable is booked once an invoice is received in the payables department (after due approvals, of course).
A provision is a liability of uncertain timing and amount. Accruals are recorded where amounts and timing are certain (or near certain). However, in the case of provisions, the amount and timing are not certain. Timing of the obligation may be one month or up to 1 year delayed, depending upon circumstances outside the control of the organization.
However, the accounting impact of booking provisions and accruals is the same. In both cases, we debit profit & loss account for the expense and create a payable account on the balance sheet. Provisions are usually created for either a legal obligation or a constructive obligation. We’ll discuss provisions in more detail in our article about IAS 37 Provisions, Contingent Liabilities and Contingent Assets.