What is Accrual Accounting?

Elise Williams

2022-06-22 17:56:10 • Filed to: Accounting • Proven solutions

One of the responsibilities of a business owner is to have a clear picture of the condition of their enterprise. This can be accomplished by performing consistent and accurate accounting. Also known as bookkeeping, it is an activity where the financial and operational health of a company is determined. It is a systematic process which involves the identification, recording, analysis, verification, classification, interpretation and presentation of financial records. There are various types of accounting today. An example is accrual accounting. This is a method of accounting which records expenses and revenues when they occur, regardless of whether cash was involved in the transactions. It is ideal for businesses which have annual sales of more than $5 million. Moreover, this bookkeeping method is highly applicable for corporations. Here is more about this method of accounting and its features.

The Definition of Accrual Accounting?

This method of accounting records revenues when they are earned for example upon issuance of an invoice. It also records expenses when incurred for example upon the receipt of a bill. Quite evident in cash vs accrual accounting, these transactions are recorded whether cash was exchanged or not. As indicated in the accrual accounting definition, this form of bookkeeping is ideal for large businesses or corporations. Moreover, it is implemented in enterprises which have some inventory.

Any businesses which sell products or services on credit are advised to implement accrual accounting. However, it is important to note that a firm that implements accrual accounting normally pays its income taxes on revenue that has not yet been received. This could negatively affect its profitability. As such, the accrual method of accounting is best implemented in firms that have a high cash flow and substantial asset base.

The Features of Accrual Accounting

Recognized and Regulated by Accounting Standards Bodies

Accrual bookkeeping is officially recognized and endorsed by the main standards bodies in the accounting industry. One of these is the Generally Accepted Accounting Principles (GAAPs). It is based in the United States. The other is the International Financial Reporting Standards (IFRS) organization. It is based in London. Both regulatory bodies provide instructions on how to record revenue and expense transactions without the presence of cash or any other evidence of monetary value transfer.

More Reliable over Time

The accrual basis of accounting is regarded as capable of providing more reliable records of accounting over time. It recognizes revenues and expenses ma more even way. As such, investors often recognize it as a highly valid method of accounting for identifying the outcomes of business operations, a firm's financial position as well as overall cash flow. As such, large corporation and multinational companies normally rely on accrual accounting.

Implement the Matching Principle of Accounting

The accrual method of accounting implements the matching principle of accounting. This means that all revenues and expenses are recorded within the same accounting period. As a result, it becomes possible to observe the complete extent of the losses and gains that a company has experienced by analyzing its business transactions over a specific period of time

Accrual Accounting Utilizes Estimates to Complete Financial Reports

In the accrual accounting method, estimates may be included in some instances. For example, if a company has some bad debts, monetary estimates can be assigned to them for the purpose of financial reporting. In doing this, an expense that is related to a specific transaction is entered into the books at the same time as the revenue. This results in a balanced income statement.

Some other elements of business transactions that may be estimated include obsolete inventory, returned products and sales allowances. It is important to note that the estimates may not be correct. This can result in financial statements that are not materially accurate.

Require Caution

The accrual concept of accounting can indicate that a firm recorded some profits while no cash inflow has occurred. This can result in a business that has very low amounts of cash assets but indicates profitability in the financial statements. In extreme cases, a business can go bankrupt despite having reported profits. Therefore, accrual accounting should only be handled by skilled and experienced accountants who can assertively oblige cash flow to prevent business failure.

Big firms, multinationals and corporations make use of accrual accounting. This method of bookkeeping records transactions even if no cash is exchanged. This accounting method can be streamlined and made more efficient by using software such as FreshBooks. As such, this Information Technology (IT) resource is an investment with a great accounting return.

FreshBooks - Software for Accural Accounting

This type of accrual bookkeeping can be performed with the assistance of computer software. An effective example of such is FreshBooks. This is a type of accounting software that can be used to perform accrual accounting. It is capable of performing accounting tasks such as transmitting invoices, managing receipts, tracking accounting periods as well as standardizing accounting tasks. This software is based on Cloud technology. Therefore, you can view your transactions from any location in the world using any Internet-connected device. You can utilize FreshBooks over a 30 day period at no cost. After that, you have to purchase it for a cost-effective price that begins at $15.

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