Accrual accounting is a concept of basic accounting principle in which all business transactions are recorded. Accrual means actual so basically, accrual accounting is done to show the actual position of the company, where does it lie. In simple words, it describes the financial status of the company.
Revenue and expenditure have a big role to show the company’s position because, without expense and revenue, we will not be able to generate our company’s net income. Until we don’t know how much revenue our company generates and how much has been spent, how will the net income come out? Even accrual accounting is incomplete without expense and revenue.
Accrual accounting is an accurate recording of revenue and expense in accounting books. In other words, it records the expenditure and revenue of the same year. Both transactions must be in the same year, only then we will be able to execute the financial position of the company by calculating the net income.
Role of accrual accounting
Accrual accounting is the accounting that records the unreceived revenue and unpaid expenses in the same year. Revenue is considered as a profit that a company earns for their high potential growth and counts as a company’s goodwill also. It is recorded as an account receivables on the side of the current asset of the balance sheet. Revenue is always distributed between shareholders who own the company with their innovative ideas and skills.
Expenses are considered as an expenditure of a company which company has to pay for goods or services to the other company or vendor so expenses are recorded as account payables on the side of current liabilities of the balance sheet. This reminds the company that the expense is still unpaid. This method allows us to collect the revenue and pay the expenses in the future and that’s why it is called the accrual basis of accounting.
This accrual accounting happens mainly in small businesses for maintaining accounting records for business transactions that are not received and not paid. This accounting method is used by small businesses for its future safe records and reminder for cash inflows and outflows that helps companies to manage the business operation and resource planning for plans. It records all the transactions of the ‘give and take’ process and exchange of cash.
- Accrual accounting records the expenses and revenue, whether its payment has not been received or made in the same year.
- The biggest thing is that both transactions should be of the same year.
- There are two types of accounting principles and accrual accounting is one of them and the other one is cash accounting.
Difference between accrual accounting and cash accounting
There are many methods of accounting but the two common methods are:
- Cash basis method
- Accrual basis method
Many business accountants use these two methods to record their commercial transactions and no accounting can ever be done properly without using these methods. So first we clarify the meaning of accrual and cash accounting with an example:
The Accrual basis of accounting is the basis of accounting in which transactions of expenses and revenue are recorded whether payment has been not received and made in the same year. The payment for these transactions is in credit. For example, Suppose a person had purchased a product of Rs.16000 from your company in 2019 and paid in 2020. So it’s not that you will record that transaction in the 2020 financial statement, but you will have to record it in the 2019 financial statement.
The issue is whether the payment of the transaction is in any year but the record is the same year that the sale took place.
The Cash basis of accounting is the basis of accounting in which transactions of expenses and revenue are recorded whether payment has been received and made in the same year. The payment of this transaction is done through cash. For example, suppose a person had purchased a product of Rs.16000 from your company in 2019 and he also paid cash at the same time in 2019. So it has been considered this transaction in cash accounting.
Different Sections of Accrual Accounting
Accrual Accounting is having a broad perspective and it is having two-section, Accrual Revenues (receivables) and Accrual Expenses (payables).
Accrued revenues are receivable income that is not in hand and it is yet to be received. In this asset are sold and income of these assets yet need to receive. In this method, the company provides their services or goods but on credit. In this accounting, revenue will be considered when the invoice is issued, not when the amount we received. This process will help us in tracking the financial status of the business. Accrued revenue shows the current assets of the company in the books.
An accrued expense is that expense in which a company does their purchases on credit and all the expenses transactions are recorded on the books when the purchase of the goods took place. In accounting, books when the expense actually happened not when they paid. Common accrued expenses include:
- Interest expense accruals
- Suppliers accruals
- Wage or salary accruals
Benefits of Accrual Accounting
- This will give you are a clear picture of the business
- Performance can be measured
- Give you accurate result
- Businesses will be updated with the financial information
- Clear financial statements help in taking better decisions
- This method helps in getting long-term investors.
Drawbacks of Accrual Accounting
- This method is very complex
- Very difficult to monitor the invoices
- Sometimes it is expensive, we have to pay taxes before the actual customer settled the account.
- Chances of limited cash flow.