Accrual accounting is a financial accounting method that allows a company to record revenue before receiving payment for goods or services sold and record expenses as they are incurred.
In other words, the revenue earned and expenses incurred are entered into the company’s journal regardless of when money exchanges hands. Accrual accounting is usually compared to cash basis of accounting, which records revenue when the goods and services are actually paid for.
What is the Accrual Concept?
The concept of accrual is the recording of expenses or revenue that has been incurred or earned but still has not been recorded in the financial statements of the business. Accruals in the business can include different transactions, such as expenses incurred but not yet paid or unpaid invoices for any services provided.
What is the Accrual Concept In Accounting?
In accounting, the accrual concept is understood as journal entries, helpful at recognising expenses and revenues that are consumed or earned, respectively. In this case, cash amounts are either not fully paid out or received by the firm.
The accrual concept in business is important, especially while creating financial statements as per the accrual basis of accounting. Within the double-entry bookkeeping process, any accrued expense is considered the liability of the firm and accrued revenue is considered business assets.
Accrual Concept Example
- Sales Accruals
Suppose ABC Company, a service-based organisation, is working on a major project handled by PBC Company. As per conditions, the billing for this project will only be done after its completion. However, while working on the project, ABC Company can accrue earnings or revenue for the work that is completed to date, even though billing for the project is not issued by PBC Company. This is considered to be revenue accruals of ABC Company.
- Wages Accruals
Consider a scenario where an employer pays wages to its employees on the 20th day of the month for the hours they worked. In such a case, employers can accrue any additional wages earned from 21st day to the end of the month, ensuring full amount of expense on wages gets recorded in financial statements.
- Interest Accruals
For instance, a lender issues a specific amount of loan to a company and sends an invoice every month to the borrower with details of interest owed. The borrower, in such cases, can record interest expense in advance for the receipts, thus specifying its accrued interest.
Importance of Accrual Concept
- Assessment of Business Performance
The performance of a business is assessed more accurately due to the application of the accrual concept. This is because accruals are portrayed in financial statements that indicate the financial health of the company. This happens due to the availability of information on accounts payable and receivable. Instant portrayal of where money is coming from and going out is expected in future reports, making performance assessment easy.
- Planning Future Financials
Accrual accounting is important as it is implemented in the business in real time, making it easy for management to have a detailed overview of finances. It also allows the accountants to assess progress from previous financial years and compare it with the present to plan for the future on an appropriate budget.
- Accurate Results
When accrual accounting is implemented in a company, it depicts a more accurate position of business finances. As debts and income of the firm are properly outlined, it helps the company manage its financials per business activity patterns.
- Implementation of the Matching Principle
The accrual method uses the matching principle method, an important factor in business accounting. In this case, expenses and revenues are reported in the same period and are ‘matched’ to determine profits or losses of that financial period.
Difference Between Accrual and Matching Concept?
- The accrual concept refers to recording the transactions whenever they are incurred or earned, regardless of actual outflow or inflow of cash. On the other hand, the matching concept specifically focuses on recognition and recording transactions of expenses in business.
- The matching concept measures the aspect of profitability of a transaction for a specific period. Whereas, the accrual concept focuses on the economic reality of transactions rather than movement in cash.
- The purpose of the accrual concept is to ensure the financial statement of the firm gives a clear picture of its financial position and performance by recognising revenues when incurred. The matching concept, on the other hand, aims to align its expenses with the revenue it generates and ensures the financial statements reflect the true cost of generating such revenues.
What are the key features of accrual accounting?
- Recognition of revenue, irrespective of receiving the cash.
- Clear recognition and treatment of expenses for an accounting period.
- The carrying forward and ongoing evaluation of expenses that are not charged to income.
- Business expenses are matched against earned revenues.