What Is Accrual Accounting, and How Does It Work?
Accrual accounting is one of the two accounting methods for recording the financial transactions of a business. It is the most preferred bookkeeping method for having an accurate and fair view of the financial position of any business.
What is Accrual Accounting?
Accrual accounting is a method of accounting that records and recognizes each transaction as it occurs. Any revenue earned or expenses incurred will be recorded in the books at the time of the transaction, irrespective of the monetary exchange.
Thus, a company will record revenue as it is earned, not when it is collected. Similarly, a company recognizes an expense when it is incurred, not when it pays it off.
Accrual accounting is the combination of the matching principle and accounting principle of accounting. According to the matching principle, the expenses for the period should match the revenue it generated for the same period.
The revenue recognition principle says to recognize the revenue when it is earned i.e., the business initiates an action that entitles it to earn revenue.
Key points:
- Accrual accounting provides an accurate and fair view of the financial position of the business. It records revenue when earned and expenses when it is incurred, thus matching revenue with expenses.
- Cash accounting is an alternative method to accrual accounting. It is ideal for some businesses. It makes bookkeeping simple and easy. It records revenue and expenses when it is received or paid.
- In accrual accounting, a business records revenue and expenses under balance sheet accounts- accounts receivable, accounts payable, prepaid assets, and accrued expenses.
How does accrual accounting work?
The accrual accounting method requires a company to record revenue and expenses in the period in which they are earned and incurred. It usually happens before or after it receives or pays money.
Accrual accounting works by recording accounts receivable and accounts payables on the balance sheet. Accounts receivables are the asset account that represents the revenue earned but not received yet. Whereas accounts payable is the liability account that represents the expense payable but not paid yet.
Understanding accrual accounting with examples:
-
Revenue example:
Suppose a company sells goods or services to its customer on trade credit, allowing the seller to pay the said amount to the buyer within the specified time limit after the transaction.
So, the revenue is earned before the actual receipt of payment, i.e., when the goods/services are delivered to the customer. You will record the amounts as accounts receivable at the time of the transaction.
-
Expense example:
Suppose you purchase goods on credit from your supplier. Your supplier issues you an invoice to be paid within 60 days.
According to accrual accounting, you will recognize an expense when receiving the goods, irrespective of the payment. You will record the expense amount in the accounts payable account at the time of the transaction.
Why do you need to outsource accounting services?
Following are some of the reasons to outsource accounting services:
- Access to professionally qualified and experienced accounting experts.
- Outsourcing helps to save administrative and overhead costs. It is affordable as compared to the full-time in-house accounting team.
- Outsourcing firms provide cloud accounting services that enable remote access to your financial data anytime and anywhere.
- Privacy and data security of the client’s data are the top priorities of outsourced accounting firms.
