CandleFocus Glossary Editor
Accrual accounting is a method of accounting that focuses on recording transactions when they occur, rather than when payment is exchanged. The accrual method follows the matching principle, which states that any revenues or expenses should be recognized in the same time period, regardless of whether payment has been exchanged. This accounting method is used in most contexts of business, and is a requirement for companies with average revenues of $25 million or more over the course of three years.
Accrual accounting is based on the double-entry accounting system, which means that any transaction is recorded in at least two accounts, sharing an equivalent value perspective. For example, when a company purchased a new machine for $5000, it would be recorded as an asset account for a value of $5000 and simultaneously debited to a liability account in order to record a $5000 external debt. Normally, accrual accounting requires two entries to fully and adequately record the transaction, which is not the case with the cash-based accounting method which only needs one entry.
With accrual accounting, companies do not wait until they received or paid the money in order to record their financial statements. Instead, they recognize the transaction when it occurs and document the payment/receipt when they record the transaction as outstanding, thus preventing potential inconsistencies.
The primary benefit of using accrual accounting is that it provides companies with a more accurate picture of their financial situation since the recorded transactions are without the time lag of cash flows. This allows companies to make better strategic decisions in the short-term and predict the long-term performance of the business. Additionally, accrual accounting enables companies to properly calculate profits or losses for their taxable phase, as the principle requires revenues and expenses to be recognized in the same period.
Given its benefits and the increasing amount of regulations regarding the use of accrual accounting, many organizations use a combination of both accrual and cash-based approaches to better organize their financial information.
Accrual accounting is based on the double-entry accounting system, which means that any transaction is recorded in at least two accounts, sharing an equivalent value perspective. For example, when a company purchased a new machine for $5000, it would be recorded as an asset account for a value of $5000 and simultaneously debited to a liability account in order to record a $5000 external debt. Normally, accrual accounting requires two entries to fully and adequately record the transaction, which is not the case with the cash-based accounting method which only needs one entry.
With accrual accounting, companies do not wait until they received or paid the money in order to record their financial statements. Instead, they recognize the transaction when it occurs and document the payment/receipt when they record the transaction as outstanding, thus preventing potential inconsistencies.
The primary benefit of using accrual accounting is that it provides companies with a more accurate picture of their financial situation since the recorded transactions are without the time lag of cash flows. This allows companies to make better strategic decisions in the short-term and predict the long-term performance of the business. Additionally, accrual accounting enables companies to properly calculate profits or losses for their taxable phase, as the principle requires revenues and expenses to be recognized in the same period.
Given its benefits and the increasing amount of regulations regarding the use of accrual accounting, many organizations use a combination of both accrual and cash-based approaches to better organize their financial information.