Accrual accounting is a system of recording revenues and expenses when they are earned and spent, regardless of the time when actual cash transactions occur. This method differs from cash accounting where transactions are started to be accounted for only after the cash is exchanged.
Content Outline
Importance of Accrual Accounting
Accrual accounting gives a better viewpoint of a company’s operating efficiency than cash-basis accounting. It shows the revenue-generating economic activities against the related expenses in the same period. These contribute to facilitating decisions and executing various economic activities, enhancing the company’s operational results and reports and compliance with the requirements of the regulations.
Key Takeaways for Accrual Accounting
Revenue and Expense Matching
Accrual accounting records revenues and expenses when they are received and incurred respectively in the period in which they occur.
Enhanced Financial Insight
This method gives better picture of operating efficiency of a company since revenue is recognized along with related expenses, so that the picture of profitability and performance becomes clearer.
Regulatory Compliance
Accrual accounting is required by many financial reporting standards, ensuring that companies comply with regulations and present reliable financial data.
Informed Decision-Making
By reflecting all economic activities, regardless of cash flow, accrual accounting aids in better strategic planning and decision-making for businesses.
Example Application
If a company provides services in one month but receives payment in the next, accrual accounting records the revenue when the service is provided, not when cash is received, giving a true representation of the company’s earnings.
Long-Term Financial Clarity
Accrual accounting provides a comprehensive performance report on financial operations so that comparisons can be made over time and used for planning purposes.
Example
Let’s say a company offers a service to customers and bills them at the end of each month. Accrual accounting would record the revenue at the time when the service is rendered to the client even if the company does not receive the cash payment the following month. This is because the said amount represents the current month’s revenue. Likewise, if a company purchases an insurance policy that costs $ 12,000 for one year in advance, then using the accrual accounting method, the expense is recognised proportionally over one year indicating the benefit obtained in each month.
All in all, the implementation of accrual accounting helps a company to get a clearer perspective of actual financial results and plan more improved strategies.