Examples of Accrual Accounting in Daily Business

Accrual accounting is the required method for most businesses to produce accurate and comparable financial statements. It governs how transactions are recorded, ensuring that financial reports reflect economic activity even when cash hasn't changed hands. For students, freelancers, and small business owners, understanding examples of accrual accounting in daily business is key to grasping how financial health is accurately portrayed in real life.

Accrual accounting ensures compliance with the matching principle by recognizing revenues when earned and expenses when incurred. This approach gives stakeholders a far more reliable picture of a company's performance than cash-basis accounting. This article breaks down five common real-life scenarios, illustrating how daily business accruals and deferrals work through clear examples and journal entries.

Real-Life Example of Accruing Revenue Before Receiving Cash (e.g., Services Billed)

A core principle of accrual accounting is recognizing revenue when it is earned, regardless of when the cash payment is received. This results in Accrued Revenue, which is income that has been earned but not yet collected.

Consulting Firm Example

Imagine a consulting firm completes a $10,000 project for a client on March 31st, but the client's payment terms allow them 30 days to pay, meaning the firm won't receive the cash until April 30th.

To provide a true picture of profitability, the $10,000 must be recorded as revenue in March, the month the service was delivered.

The benefit is that the Income Statement for March accurately reflects the full $10,000 in revenue, allowing for a correct calculation of the firm's monthly profitability.

Illustrating Accrued Expenses: Recording Utility Costs Before the Bill Arrives

Accrued Expenses are costs that a business has incurred (used) but has not yet paid or received an invoice for. They must be recorded to adhere to the matching principle, ensuring expenses are matched to the period in which they helped generate revenue.

Electricity Use Example

A small manufacturer uses electricity throughout March, but the utility company doesn't issue the bill until April 10th, and payment is due April 30th. At the end of March, the accountant estimates the utility expense to be $800.

To ensure the utility cost is matched to the March revenue, an adjusting entry is needed on March 31st:

When the actual bill arrives in April and is paid, the payment entry clears the liability:

Recording the liability in March is essential; otherwise, March's profitability would be overstated by $800.

How Prepaid Expenses (e.g., Rent, Insurance) Are Handled Under Accrual Accounting

Prepaid Expenses are payments made in advance for goods or services that will be consumed or used in a future accounting period. Under accrual accounting, these initial payments are recorded as an asset, and the expense is recognized only as the benefit is consumed over time.

Annual Insurance Payment Example

A business pays $12,000 for a one-year general liability insurance policy on January 1st.

Step 1: Initial Payment (Journal Entry)

The initial payment is recorded as an asset, as the company has not yet used the insurance coverage:

Step 2: Monthly Adjustment (Adjusting Entry)

Each month, the company uses 1/12th of the policy, so $1,000 ($12,000 / 12 months) must be recognized as an expense. This adjustment moves the cost from the asset account to the expense account:

This process is repeated every month for a year, ensuring that the expense is spread accurately over the coverage period.

Accounting for Unearned Revenue (Deferred Revenue) in a Subscription Business Model

Unearned Revenue (often called Deferred Revenue) is cash received by a business before the service is delivered or the goods are provided. Because the revenue has not yet been earned, the initial cash receipt is recorded as a liability—an obligation to the customer.

Software Subscription Example

A software company sells an annual subscription for $600 on October 1st. The service will be delivered over the next 12 months.

Step 1: Initial Cash Receipt (Journal Entry)

The full $600 is received, but it is recorded as a liability because the company owes the customer 12 months of service:

Step 2: Monthly Revenue Recognition (Adjusting Entry)

Each month, 1/12th of the service is delivered, allowing the company to recognize $50 ($600 / 12 months) as earned revenue:

This process accurately aligns revenue recognition with service delivery, preventing the overstatement of profits in the month the cash was received and ensuring the balance sheet accurately shows the remaining obligation.

Step-by-Step Journal Entries for Basic Accruals and Deferrals

The following table summarizes the four core journal entries for accrual accounting, illustrating the timing and impact on the financial statements.

Understanding this mechanism is fundamental to achieving clarity, accuracy, and compliance with the matching principle and other accounting principles.

Conclusion

Accrual accounting provides a more accurate, reliable view of a business's finances than the cash basis by systematically recording transactions when they occur, not just when cash changes hands.

Mastering these examples of accrual accounting—from recording accrued revenue and expenses to managing prepaid and unearned revenue—equips students, future accountants, and small business owners with the essential skills to maintain accurate financial records and make informed decisions.

From revenue recognition to the proper recording of expenses, accrual accounting keeps your financial picture clear, complete, and ready for sustainable growth.