Understanding the Importance of Accruals for Both Employees and Employers

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Businesses need to track their expenses. It's how they ensure they're heading in the right direction, reaching their objectives, remaining profitable, and sustaining themselves. However, it isn't always easy.

Some examples of these expenses include

- A client receiving a service from a company but has not yet paid

- Employees accumulating paid time off they haven't used, which employers must account for

These situations can complicate a business's accounting process because, technically, money hasn't changed hands yet. Since a business' finances affect employers and employees differently, accountants rely on accruals to ensure that a company's financial statements are always accurate.


What are Accruals?

An accrual is a recorded amount businesses still need to pay or receive. These include accounts receivable and compensations they will provide their employees. Companies have accruals to ensure they have a consistent picture of their financial status.

From an employer's point of view, they need accruals to ensure accurate accounting of their finances. On the other hand, employees benefit from accruals because it protects them against feeling undervalued and underpaid.


Accruals for employers

To put this into better perspective, here's an example. Suppose a client asks a design company for posters and banners in May for an event in June; the client will pay after the event. Despite not receiving payment, the design company must produce the marketing collaterals in May.

Since the client technically availed of the design services in May, the design company will include the revenue in their May financial calculations despite receiving the money at the end of June. The money they earned in May is an accrual.

Employers must be aware of a few accruals to sustain their company's financial health.

1. Accounts payable

Accounts payable refer to the money a business owes its suppliers, vendors, and creditors for goods or services they acquired but haven't paid for. They typically record these as liabilities in their balance sheet until they can finally pay them.

For example, suppose a company purchases $10,000 worth of goods from a supplier on credit. The company will record the amount in its accounts payable ledger and pay the supplier later according to an agreed-upon payment term. That said, payment terms typically range from 30 to 90 days.

Managing their accounts payable ledger well allows businesses to maintain good relationships with suppliers and vendors and reminds them to pay on time, avoiding interest charges and late fees.


2. Accounts receivable

Accounts receivable refer to the money a business owes its customers for goods or services sold but have not paid for. Accounts receivables are recorded as assets until they receive the payment.

For example, suppose a company sells $20,000 worth of goods to a customer on credit. The company will record the amount as an asset in its accounts receivable ledger until the customer pays completes paying the total amount after a specified term.

These accruals help businesses maintain a healthy cash flow and potentially avoid bad debts or write-offs. 


3. Accrued interest

Accrued interest is the interest accumulated on a financial asset but not yet paid or received, similar to accounts payable and receivable. 

Businesses usually calculate this based on the principal amount, interest rate, and period when they earned the interest. Depending on the nature of the accrual, they can then record it as either a liability or an asset. For instance, accrued interest on a loan is a liability; on an investment, it's an asset.


Accruals for employees

Depending on your country's labor policies and the stated employee benefits from your contract, you're entitled to a certain number of paid leaves. Your employers have already set aside money for the leaves, regardless of whether you file them. As long as you don't use the leaves you've earned and are entitled to, it represents an accrual in your employer's books. 

You need to understand different forms of accruals to prevent you from feeling undervalued or under-compensated.


1. Vacation accruals

Vacation accruals track the amount of paid time off employees have earned but have not yet used. Each time an employee works, they earn a certain amount of vacation time that they can use later. For instance, you can be entitled to one additional day of vacation leave per month you worked throughout the year. 

Understanding how your vacation accruals work can help you plan your time off accordingly, ensuring you don't spend less or more than you earned.


2. Sick Leave accruals

Sick leave accruals track how much paid time off employees earn to use when they're sick. It's similar to how vacation accruals work, where you can become eligible to receive a certain number of sick leaves based on how long you've worked at the company.

Understanding how sick leave accruals work can help employees comfortably take much-needed time off when they're sick without worrying about losing their pay.


3. Bonus accruals

Bonus accruals refer to how much money employees can receive as a bonus. Employees can receive compensation whenever they reach a specific goal or perform up to a company standard. For example, if an employee is eligible for a $1,000 bonus for meeting their sales goals, they might accrue a portion each month they meet their goals.

Being aware of bonus accruals can guide your work toward achieving a goal and help you understand how your employer can compensate you fairly for your above-average performance.

Wrapping Up

Employers need to understand accruals because it allows them to keep an accurate record of their finances. These records are invaluable for determining the company's financial health. Failure to consider accruals may lead to overspending on taxes and mismanaging funds, leading to financial headaches and business challenges.

However, employers aren't the only ones who need to know about accruals. Employees must also know about them because it affects employees too. Understanding accruals lets them know how much compensation an employee can expect to be entitled to, and misunderstanding can lead to the employee feeling underpaid and undervalued.

Whether you're an employer or an employee, accruals can confuse those who aren't fluent in accounting and can be overwhelming to start learning about. However, it's worth the effort to understand its basics and importance, regardless of your business affiliation.

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