What Is An Over Accrual?

When you’re running a business, keeping your financial records accurate and up to date is critical: it sharpens decision-making, improves forecasting and ensures compliance. 

But even with the best intentions, mistakes happen. One of the most common? Over accruals.

What is an over accrual, how does it impact your accounting, and how can you correct it? Let’s find out!

What Is Accrual Accounting?

Before discussing accruals, you’ll first need to understand the difference between cash accounting and accrual accounting.

Cash accounting records money at the moment it changes hands. Receivables and payables are not tracked until the money is coming into or going out of your operations.

This method is simple to maintain, and it gives you a clear picture of how much cash you have on hand at any given moment. However, cash accounting doesn’t give you a full picture of your liabilities. It may not work for larger, more complex businesses, or ones that offer customers lines of credit.

Accrual accounting, on the other hand, records revenue and expenses only when they are earned, not necessarily when the payment is received. Typical accruals include payroll, utilities, subscriptions and interest. 

This method is more common for larger, more complex companies, and many smaller companies end up switching over to this method as they grow.

While accrual accounting is more complicated, it provides you with a more accurate picture of your company’s financial situation, which can help you make better financial decisions in the future.

It’s worth noting that accrual accounting does not give you a complete picture of your cash flow, so you’ll need to keep track of it separately to avoid running out of funds.

What Is An Over Accrual?

When a company does accrual accounting, it estimates future expenses to help determine its budget. An over accrual occurs when too high of an estimate is made for an expense or revenue that hasn’t actually been incurred yet.

As an example, let’s say that your company estimates that a certain utility bill for April will be $1000, based on previous months and years. You record that as an accrued expense in your journal. 

But when the utility company sends the bill over, it turns out that you actually owe $900. This estimation error results in an over accrual, which must be corrected to keep your books accurate.

Why Do Over Accruals Happen?

Over accruals may happen for several reasons:

• Misestimation: Accrual accounting relies on forecasting what your expenses are going to be in the future. It’s hard to predict the future, though, especially for expenses that fluctuate month to month, and estimation errors sometimes occur.
• Poor Communication: Delayed customer payments or last-minute vendor changes can throw off your numbers. Clear, consistent communication with clients and suppliers helps prevent surprises and keeps your accruals accurate. 
• Timing Issues: Seasonality can play a big role in accrual accounting. Accruals may fluctuate based on the time of year, depending on your industry, utility costs, payroll, and other variable expenses. This should be taken into account when recording your expenses.

Why Do Over Accruals Matter?

Overstating your expenses might not seem like a big problem. After all, you have more money than expected, right?

Over accruals can actually lead to several major issues, especially if they’re not corrected:

• Inaccurate Financial Statements: When you overstate your expenses or understate your profits, your profit margins will be inaccurate. That means your financial statements will be misleading to both you and to potential investors.
• Negative Effect on Business Decisions: Your accounting should always be as accurate as possible. Inaccurate expenses or profits can lead to serious budgeting and forecasting errors, as well as misleading KPIs.
• Compliance Issues: Over accruals can lead to potential audit issues and compliance risks come tax time. Dealing with them now is far easier than dealing with legal trouble later.

How Can I Identify and Correct Over Accruals?

It’s important to know how to identify an over accrual in the first place so you can catch it before it becomes an issue. 

1. Run Variance Analysis
   Compare actual costs to forecasted ones each reporting period. This helps you spot discrepancies quickly—and tells you whether the variance is favorable or not.
2. Adjust After Invoicing
   Once invoices are in, revisit your journal entries. Update any accruals to reflect actual costs. It keeps your books clean and your statements accurate.
3. Watch for Patterns
   Frequent over accruals? That’s a red flag. Identify where the biggest variances are and refine your forecasting process to prevent repeat errors.

Tips to Help Prevent Over Accruals

Use Historical Data

Your company’s own historical financial data is usually the best and most accurate way to estimate future expenses. Be sure to adjust your numbers for seasonal trends, changes in vendor pricing and inflation.

Automate Your Accrual Process

Automating accrual accounting takes a lot of the guesswork out of the process. Software like QuickBooks has accrual models built in, allowing you to stay consistent and reduce the risk of overestimating or underestimating your expenses.

Regularly Review Your Accounts

Perform monthly, quarterly and yearly reviews of your accruals to check that everything is still accurate. Frequent reviews help catch any mistakes and prevent errors from snowballing into bigger issues further down the road.

Outsource Your Accounting

It’s tough to keep your accruals accurate, especially if you don’t have a budget to hire a full-time accountant for your small business. At the same time, accurate financials are the key to keeping your cash flow steady and your operations fully compliant. 

Why not make your life easier by partnering with an outsourced financial team? Finvisor has been helping small businesses just like yours with accounting and CFO support for over a decade. We’ll keep your books straight and help guide your business as it grows. 

Contact us today to learn how we can help!