What it is:
How it works (Example):
For example, let's assume Company XYZ must insure one of its buildings. The insurance company bills Company XYZ $600 every six months (one bill in January, the next in July). If each bill is for the last six months of coverage ($100 for each month times six months), then under the accrual method, Company XYZ essentially starts settingaside for the months for which it has received insurance coverage but hasn't yet paid.
So, let's say that it's January. Company XYZ paid its bill for the last six months of coverage and won't get another bill from the insurance company until July. Thus, in January it records an accrued liability for $100 worth of insurance. In February, it adds another $100 to that accrual. In March, it adds another $100. In April, May and June, it adds $100 for each month to the accrued liability, too.
In July, the bill finally comes. At that point, Company XYZ has an accrued liability for $600 -- the amount of the insurance bill for the last six months of coverage. When it pays the bill, it reduces theto zero. The process starts again for the next six months.
Why it Matters:
Although it is more complex, harder to implement, and harder to maintain than the analysts agree that accruals (and thus, accrued liabilities) provide a more accurate picture of a company's performance. That's because in any given , are associated with their corresponding expenses, which gives a truer picture of the real costs of producing the in a given period.method of , most
Additionally, sales may have been made and expenses incurred even if cash has not changed hands yet (as is often the case with sales made on credit and similar circumstances). This in turn produces financial statements that are comparable over time.allow companies to reflect the fact that
However, one of the big drawbacks of accrued liabilities is that they tend to obscure the nature of the company's actual cash position (e.g., a company may show millions in sales but only have $10 in its cash account because its customers haven't paid yet).
cash accounting, which recognizes economic events only when is exchanged. The accrual method is more common than the cash method, and the IRS often requires companies to use when they have more than a certain level of or carry inventory.is the opposite of