See Also:
Time Saving Tip for Filing Accounts Payable Invoices
Statement of Financial Accounting Standards - SFAS
Generally Accepted Accounting Principles (GAAP)
General Ledger Reconciliation and Analysis
Future of the Accounting WorkforceAccrual Based Accounting Definition
The accrual based accounting definition, or accrual basis accounting, forms a method of recording financial transactions based on economic impact. In the accrual accounting method, revenues are recorded when they are earned and costs are recorded when they are incurred, whether or not cash has actually been exchanged between the relevant parties. This method contrasts with cash basis accounting, which records transactions only when cash has been exchanged between the relevant parties. The accruals concept is well used in the accounting world, where accruals accounting is more commonly used than cash accounting. The accrual definition may also vary based on industry and business model.
Cash Basis Accounting Method
Cash basis accounting is a method of recording financial transactions which records transactions only when cash has been exchanged between parties. This contrasts with accrual basis accounting, which records transactions based on economic impact. When thinking about accrual vs cash accounting remeber that accrual keeps record of any sales where cash keeps record of income only. It is also possible to perform accrual to cash adjustments and conversions in accounting records.
Cash vs Accrual Basis
When a company sells its product to a customer, it must record the transaction. Using cash basis accounting, the company would not record the revenue from the sale until it received the cash from the customer. Using the accrual method of accounting, the company would record the revenue from the sale once the customer has received the product, whether or not the company has received the cash from the customer. The accrual method seeks to record the entire process of a transaction.
Accrual basis accounting gives a more accurate depiction of a company’s financial condition. However, it is more complicated and more costly to implement than cash basis accounting. Accural accounting is often used in situations with complexities beyond that of the simple
sole proprietorship.
All companies that report financial statements according to GAAP rules use accrual accounting. Only very small and unsophisticated businesses (a local coffee shop, an antique store with little inventory, etc.) would use cash basis accounting.
Accrual Principle
Accrual basis accounting is derived on two fundamental accounting principles: the revenue recognition principle and the matching principle.
Revenue Recognition Principle – GAAP
The revenue recognition principle states that revenue is recognized when it is earned. Revenue is considered earned when the company has fulfilled its obligation to the customer. For example, if a customer orders a product from a company, the company can record the sale once it has delivered that product to the customer, even if the customer has not yet paid. Here, accruals have occured which leave
accounts receivable to be collected.
Matching Principle – GAAP
The matching principle states that expenses are recognized in the period when they are incurred. For example, a company will recognize employee wages as an expense during the period when those wages are earned, even though the employees don’t actually get paid until the next period.
Accrual Basis Statements
According to GAAP, and in accordance with the revenue recognition principle and the matching principle, all financial statements must be prepared using accrual accounting.