The accounting accrual It is an accounting method that records income and expenses at the time they are incurred, regardless of when the cash is exchanged for them. This method measures the position and performance of a company by recognizing economic events, regardless of when cash transactions occur..
The underlying idea is that by combining expenses with income, under the principle of correspondence, economic events are recognized at the time the transaction occurs, rather than when the payment is received or made..
Accounting accrual allows current cash inflows / outflows to be combined with future cash inflows / outflows to provide a more accurate picture of a company's current financial situation..
Most companies typically use one of two accounting methods in accounting systems: cash basis or accrual basis..
Accrual accounting is the opposite of cash accounting, which recognizes transactions only when there is a cash exchange.
Article index
Accrual accounting is considered to be standard accounting practice for most companies. Very small companies are excepted.
The need for this method was born out of the desire for more accurate financial information and the gradual complexity of business transactions.
Projects that provide cash flows over a long period of time and sales on credit affect the financial condition of the company when the transaction occurs..
For this reason, it makes sense that these events are also reflected in the financial statements during the same reporting period in which these transactions occur..
According to the accounting accrual, companies receive an immediate response of their expected cash inflows and outflows. This makes it easier to better manage your current resources and plan effectively for the future..
The disadvantage of this method is that income tax is paid on the income before it has actually been received..
A business that incurs an expense that has not yet been paid will recognize the business expense on the day the expense arises. According to the accounting accrual method, the company that receives goods or services on credit must report the liability on the date they were received..
The accrued expense will be recorded as an account payable in the current liabilities section of the balance sheet. Also as an expense in the income statement. When paying the invoice, the general ledger debits the accounts payable account and the cash account is credited.
The cash method is the simplest. This is because the accounting books are kept based on the actual cash flow, inside and outside the business. Income is recorded when collected and expenses are reported when actually paid.
That way, the income record can be postponed until the next fiscal year. On the other hand, expenses are taken into account immediately.
With the accrual method of accounting, income and expenses are recorded as they occur, regardless of whether the cash has changed hands or not..
An excellent example is a sale on credit. The sale is recorded in the books when the invoice is generated and not when the cash is collected. Similarly, an expense occurs when ordering the materials, not when the check is actually written..
Companies with inventory must use the accrual method. It is also recommended for companies that sell on credit. This is because it more accurately matches income and expenses over a given period of time..
Consider a consulting firm that provides a $ 5,000 service to a client on October 30. The client receives the invoice for the services provided and makes his payment in cash on November 25.
The entry of this transaction will be recorded differently based on the cash and accrual methods of accounting. With the cash method, the income generated by the consulting services will be recognized only when the company receives the money.
A company that uses the cash method of accounting will record revenue of $ 5,000 on November 25..
However, the accounting accrual says that the cash method is not accurate. This is because the company will receive the cash at some point in the future for the services that have already been provided..
Therefore, the accrual method recognizes income when the services provided to the customer end, even if the cash is not yet in the bank. Income will be recognized as earned on October 30.
The sale is recorded in an accounts receivable account. This is in the current assets section of the balance sheet.
An example of an expense and liability accrual is a major repair that occurs in the last month of the accounting year. However, this is not paid until the invoice is received in the first month of the following year..
In order for the financial statements for the current year to be complete, according to the accounting accrual method, the following is necessary:
- The income statement for the current year must report the repair expense.
- The balance of the last day of the year must report the related liability.
To record this accrual, an adjustment entry is made. It is debited to the Repair Expenses and the Accrued Expenses payable are credited.
An example of accrual of income occurs in the electric company. For example, during December this utility probably uses natural gas and / or coal, in addition to many employees, to generate the electricity used by its customers in December..
However, the utility does not bill its customers for that electricity until after reading the meters in January. As a result, the utility's financial statements will need an accrual adjustment so that:
- Your income statement for the month of December and for the current year report all the income obtained by the public service company.
- Your balance sheet as of December 31 reports a current asset for the amount entitled to receive from your customers. This including the amount of electricity you provided in December.
The accrual adjustment will debit the accumulated accounts receivable from the current assets account. On the other hand, it will credit the accumulated electricity income from the income statement account.
Yet No Comments