Key Points
- Accrual accounting records revenue when earned and expenses when incurred, regardless of cash timing.
- IAS 1.27 mandates the accrual basis for all IFRS financial statements except the statement of cash flows.
- Failing to accrue period-end liabilities is one of the most frequent causes of audit adjustments on mid-market engagements.
- Year-end accruals for unbilled services or goods received but not invoiced often represent 2% to 8% of total operating expenses.
What is Accrual Accounting?
IAS 1.27 states that an entity shall prepare its financial statements on the accrual basis of accounting, with the sole exception of cash flow information. The Conceptual Framework (paragraph 1.17) explains why: accrual accounting provides information about past transactions and events that is more useful for assessing future cash flows than information solely about cash receipts and payments during the period.
In practice, the accrual basis creates timing differences between economic events and cash movements. When an entity receives goods in December but pays the supplier in January, the expense belongs in December's income statement and a payable appears on the December balance sheet. When an entity delivers services in November but invoices the customer in January, the revenue belongs in November and a contract asset (or accrued receivable) appears on the November balance sheet.
The auditor's concern centres on completeness and cut-off. ISA 500.A14 links the assertion of completeness directly to whether all transactions that should have been recorded are in fact recorded. Cut-off testing under ISA 330.A53 targets the boundary between periods, which is precisely where accrual accounting requires the most judgment. Entities with weak purchase-order or service-delivery tracking systems routinely understate period-end accruals because invoices have not yet arrived.
Worked example
Client: Italian food production company, FY2025, revenue EUR 67M, IFRS reporter. Rossi operates from two production facilities and sources raw materials from over 40 suppliers across southern Europe. The finance team closes monthly but relies on invoice receipt dates for expense recognition during the year, running a manual accrual process only at the annual reporting date.
Step 1 — Identify items requiring accrual at 31 December 2025
The auditor examines post-year-end supplier invoices received between 1 January and 15 February 2026. A sample of 35 invoices totalling EUR 2.1M relates to goods delivered or services performed before 31 December 2025. Management's accrual schedule captures EUR 1.85M of these items. The gap is EUR 250,000.
Documentation note: record the population of post-year-end invoices examined, the sampling basis (all invoices above EUR 10,000 plus a random sample of smaller items), the delivery or service dates confirmed per goods-received notes and delivery dockets, and the total unrecorded liability identified.
Step 2 — Evaluate the missing accrual
The EUR 250,000 gap consists of four invoices. Two are for packaging materials delivered on 22 December (EUR 140,000). Two are for equipment maintenance performed in the last week of December (EUR 110,000). Management did not accrue these because the invoices arrived in late January.
Documentation note: record the nature of each unaccrued item, the evidence of pre-year-end delivery or performance (goods-received notes, maintenance completion certificates), and the reason management's process missed them.
Step 3 — Assess materiality and propose the adjustment
Overall materiality for the engagement is EUR 1.0M. Performance materiality is EUR 650,000. The EUR 250,000 understatement is below performance materiality on its own but is added to the summary of uncorrected misstatements. Together with two other cut-off errors identified elsewhere (EUR 180,000), the cumulative total reaches EUR 430,000. The auditor discusses the adjustment with management.
Documentation note: record the proposed adjustment (debit cost of sales EUR 140,000, debit maintenance expense EUR 110,000, credit accrued liabilities EUR 250,000), the position on the summary of uncorrected misstatements per ISA 450.A5, and management's response.
Step 4 — Test management's accrual process for reliability
The fact that EUR 250,000 slipped through indicates a process gap in the goods-received-not-invoiced (GRNI) reconciliation. The auditor documents the weakness as a control deficiency under ISA 265.A1 and considers whether it affects the risk assessment for accounts payable completeness.
Documentation note: record the control deficiency, the communication to those charged with governance per ISA 265.9, and any impact on the planned substantive approach for payables cut-off.
Conclusion: the accrual adjustment of EUR 250,000 is defensible because each item is supported by pre-year-end delivery or service evidence, and the GRNI reconciliation gap explains why the entity's own process missed them.
Why it matters in practice
- The FRC's 2022/23 inspection cycle noted that auditors on smaller engagements frequently rely on management representations about period-end accruals without performing independent cut-off procedures. ISA 330.A53 requires substantive procedures directed at the cut-off assertion, and a management representation alone does not constitute sufficient appropriate audit evidence under ISA 500.9.
- Teams sometimes limit post-year-end invoice testing to purchase invoices and overlook accrued liabilities for services (legal fees, consulting, utility charges). IAS 1.27 makes no distinction between goods and services when applying the accrual basis. If the service was performed before year-end, the liability exists regardless of when the provider invoices.
Accrual accounting vs. [cash basis accounting](/glossary/cash-basis-accounting)
| Dimension | Accrual accounting | Cash basis accounting |
|---|---|---|
| Recognition trigger | When the economic event occurs (delivery, performance, consumption) | When cash is received or paid |
| Revenue timing | Recognised when earned, per IFRS 15 or local equivalent | Recognised on receipt of cash |
| Expense timing | Recognised when incurred, matched to the period of economic benefit | Recognised on payment |
| IFRS compliance | Mandatory for all IFRS financial statements except the cash flow statement (IAS 1.27) | Not permitted under IFRS for general-purpose financial statements |
| Audit relevance | Cut-off and completeness assertions are central; period-end accruals require judgment | Minimal cut-off risk, but statements do not reflect economic reality |
Cash basis accounting eliminates the timing judgments that accrual accounting creates, but it produces financial statements that fail to reflect the economic substance of transactions. That is why IAS 1.27 prohibits it for IFRS reporters. The auditor encounters cash basis accounting primarily when testing internal management reports or when auditing entities transitioning from cash-basis local frameworks to IFRS.
Related terms
Frequently asked questions
How do I test accruals during an audit?
Select a sample of invoices received after year-end and trace each one to the delivery date or service-performance date. If the economic event occurred before the reporting date, confirm the item appears in the period-end accrual schedule. ISA 330.A53 directs cut-off procedures to the boundary between adjacent periods. Also test in the opposite direction: sample items from the accrual schedule and verify that supporting evidence confirms the pre-year-end timing.
Does accrual accounting apply to small entities reporting under local GAAP?
Yes, in nearly all European frameworks. IAS 1.27 mandates the accrual basis for IFRS reporters. Dutch GAAP (RJ 115.201) and HGB Section 252(1)(5) both require accrual-basis preparation. The only common exception is micro-entities in certain jurisdictions that are permitted to use simplified bases, but even these typically require accrual accounting for material transactions.
What is the difference between an accrual and a provision?
An accrual relates to an obligation where the timing and amount are known or can be estimated with reasonable precision (e.g., a utility bill for December received in January). A provision under IAS 37.14 relates to a liability of uncertain timing or amount, requiring a probability assessment and a best estimate. The key distinction is the degree of uncertainty. IAS 37.11(b) explicitly excludes accruals from the scope of IAS 37 because their measurement uncertainty is low.