INTRODUCTION
Accrual accounting, or the Mercantile basis of accounting, is a popular method that recognises revenue and expenses when earned or incurred, irrespective of when payment is received.
In other words, the revenue earned and expenses incurred are entered into the company’s journal regardless of when money is transferred.
ACCRUAL BASIS OF ACCOUNTING
The general concept of accrual accounting is that accounting journal entries are made when the transaction occurs rather than when payment is made or received. Accrual basis accounting combines two key accounting principles: the matching principle and the revenue recognition principle.
The revenue recognition principle requires that organisations recognise revenue when earned, even if payment is received later. The matching principle requires that expenses be recognised in the same reporting period as the revenues that they are related to.
The alternative method of recording accounting transactions is the cash basis, which is the practice of recording revenue when cash has been received, and recording expenses when money has been paid out.
Benefits of Accrual Basis of Accounting
The accrual basis of accounting shows a clear picture of the entity’s financial position and performance.
Generally accepted accounting practices (GAAP) and Accounting Standards prefer the Accrual Basis over the Cash Basis of Accounting.
Other advantages of the accrual basis of accounting include:
- Real-time view of financial information
- Accurate assessment of finances.
- Proper management of debt and income
Disadvantages of Accrual Basis of Accounting
- It is more complex and time-consuming compared to other methods of accounting.
- It does not reflect a company’s cash flow.
- Skilled professionals are required to maintain accounts on an accrual basis.
Difference between cash basis and accrual basis
| Cash basis of accounting | Accrual basis of accounting | |
| Definition | Records revenue and expenses only when cash is received or paid | Records revenue and expenses when earned or incurred instead of money when cash is received |
| Timing | Transactions are recorded when cash is accepted or paid | Transactions are recorded when they are made or incurred |
| Accuracy | Ideal for larger companies with more complex operations | Provides a more accurate picture of a company’s financial situation and performance |
| Complexity | Simpler and easier to maintain | More complex and time-consuming |
| Suitability | Suitable for small businesses with simple operations | Ideal for larger businesses with more complex operations |
| GAAP Compliance | Not compliant with Generally Accepted Accounting Principles (GAAP) | Compliant with GAAP and other accounting standards |
Use of technology for accrual basis of accounting
Challenges caused due to the complexity of the accrual basis of accounting can be reduced by using accounting software. You can automate the accounting process, from recording transactions to generating financial statements. Using accounting software helps minimise errors by reducing manual data entry. Technology can help simplify the accrual method of the accounting process and improve accuracy and efficiency.
CONCLUSION
In conclusion, the accrual basis of accounting is a method that recognises revenue and expenses when earned or incurred, regardless of when payment is received. It combines the principles of revenue recognition and expense matching, providing a more accurate picture of a company’s financial position and performance.
While the accrual basis offers numerous benefits, such as real-time financial information and proper management of debt and income, it is more complex and requires skilled professionals for maintenance. In contrast, the cash basis of accounting records transactions only when cash is received or paid, making it simpler but less accurate. Technology, such as accounting software, can help overcome the challenges associated with the complexity of accrual accounting, simplifying the process and improving accuracy and efficiency. Overall, the accrual basis of accounting is widely preferred and compliant with accounting standards, making it suitable for larger businesses with more complex operations.
BY JAKS KOCHI