Accrual Accounting

What is Accrual Accounting?

Accrual basis accounting is a method of accounting in which transactions are recorded when they occur, regardless of when the payment is received or made. This method follows the Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS).

How Does it work?

To better understand how accrual accounting works, consider the following example: a company sells $10,000 worth of products to a customer on December 31st, but the customer does not pay until January 15th of the following year. 

With accrual accounting, the company would recognize the revenue of $10,000 in the year the sale was made, which is December 31st, even though the payment is received in January of the following year.

Principles of Accrual Accounting

The accrual basis of accounting is based on two principles: 

Revenue Recognition Principle: The revenue recognition principle states that revenue should be recognized when it is earned, regardless of when payment is received

Matching Principle: The matching principle states that expenses should be recognized in the same period as the revenue they helped to generate.

Accrual Accounting

Accrual basis accounting provides a more accurate picture of a company's financial position, as it takes into account all revenue and expenses, regardless of when they are paid or received. This makes it easier for companies to track their financial performance over time and make informed decisions about their business. Additionally, accrual basis accounting is required by generally accepted accounting principles (GAAP) for most businesses.

However, accrual basis accounting can be more complex and time-consuming than cash basis accounting. Companies must keep detailed records and make adjustments at the end of each accounting period to ensure that their financial statements are accurate. Additionally, accrual basis accounting can make it more difficult for companies to manage their cash flow, as revenue is recognized before it is received and expenses are recognized before they are paid.

Cash basis accounting, on the other hand, is simpler and easier to use than accrual basis accounting. It provides a more accurate picture of a company's cash flow, as revenue is recognized when cash is received and expenses are recognized when cash is paid out. This makes it easier for companies to manage their cash flow and make informed decisions about their business.

However, cash basis accounting can be less accurate than accrual basis accounting, as it does not take into account all revenue and expenses. Additionally, cash basis accounting is not allowed under GAAP for most businesses, which can limit its use.

In summary, both accrual basis and cash basis accounting have their advantages and disadvantages. Companies must choose the method that best fits their needs and meets their reporting requirements.