Accrual Accounting: What it is & how it works?

Accrual Accounting


What are Accruals?

Accrual is a way by which businesses record expenses or revenues at the time of their occurrence and not when cash is paid or received. In case of accruals, entry is recorded in the books of accounts when the invoice is generated or received and not when the cash is paid or received. For example – ABC Ltd. Company has given services to XYZ Ltd. in April 2018 and recorded the income in their books of accounts in April 2018 when they give the services. Company received the payment from XYZ in June 2018. It means company recognizes its sales and recorded the revenue when invoice was created and not when they received the cash.

Types of Accruals

There are two types of accruals –

  1. Revenue – As per accrual basis of accounting, income or revenue is recorded in the books of accounts when it is earned not when the cash is received. For example – On 15th November, Saurabh’s company sells two buses to Company B. They sold the buses at £10,000 on 15th November but company B done the payment of £10,000 on 20th December. As per accrual basis of accounting, Saurabh’s company already recorded the revenue in their books of accounts on 15th November even when the payment has not been received from the buyer till 20th December.

  2. Expense – On accrual basis of accounting, expenses are recorded in the books when it is incurred and not when it is paid. For ex- ABC ltd. company received an electricity bill of £2000 from the electricity company on 18th December 2018 for which the payment has been done on 26th December 2018. It is an expense and must be recorded in the books of accounts on 18th December 2018, when the expense has been incurred and the invoice has been received not on 26th December 2018, when the payment has been done.

What is Accrual Accounting?

Accrual accounting is a method of recording expenses or revenues in the books of accounts at the time of its occurrence not at the time when the cash is paid or received. For ex – ABC Ltd. Company sold two vehicles to XYZ Company on 15th December 2018 & XYZ Company has done the payment for the same on 25th December 2018. As per accrual basis of accounting, ABC Ltd. has to enter this income in their records on 15th December 2018 at the time of its recognition and not on 25th December 2018. If XYZ Ltd. Company is also using the same method i.e. Accrual basis of accounting, XYZ ltd. must enter the expense in their books on 15th December rather than considering the payment date i.e. 25th December 2018.

Accrual Accounting

How Accrual Accounting works?

Accrual accounting is a method used by many businesses to record expenses & revenues at the time of their occurrence rather than time of exchanging cash. In accrual accounting, a revenue or expense entry has been recorded in the books of accounts at the time the invoice is generated or received rather than the time when cash exchange happens. For ex – If you are selling any item to a customer on credit in the month of November, you have to record the transaction immediately in November at that particular date as an item in account receivable. The transaction will be recorded as income for the month of November only even If customer doesn’t make cash payment for that item till December

The same rule applies when you buy the goods on credit. The items purchased in the month of November will be recorded as an expense for the month of November only & not when you will pay for the same.

Therefore, business expenses are recorded when you receive products & services and revenue is recorded when you sell products & services and not when you pay or receive cash.

What are the benefits of Accrual Accounting?

The benefits of accrual accounting are as follows –

  1. It is recognized by companies act.

  2. It gives you much clearer picture of your business performance and profitability.

  3. It gives you much more confidence in taking financial decisions.

  4. It includes all expenses and all incomes rather than focusing only on cash transactions.

  5. It also helps in postponing your tax liability, if you received any advance payment for the services you have to perform till the end of the year. You can delay payment of taxes on that income until the next tax year.

  6. It also helps in forecasting and you might make an estimate of your future expense reports.

  7. With the help of accrual accounting, sometimes it becomes easier to pitch for long term finance.

  8. It is more accurate method of accounting in comparison to cash accounting.

Difference between Cash Accounting & Accrual Accounting

Basis of Distinction Cash Accounting Accrual Accounting
Meaning Cash accounting is a method of recording expenses or revenues at the time when the cash is paid or received Accrual accounting is a method of recording expenses or revenues at the time of their occurrence and not at the time when payment is done.
Recording of Expense or Revenue Recording of expense or revenue happens when cash is paid or received Recording of expense or revenue happens when expenses are incurred or revenue is earned
Revenue recognition Revenue recognition is delayed under this system of accounting Revenue is recognized at the same time
Inclusions Only cash expenses & cash incomes are included It includes all incomes and all expenses.
Nature It is very simple & easy to understand It is complex
Recognized by It is not recognized by companies act It is recognized by companies act
Holistic approach No, it is not holistic in approach as it only talks about cash Yes, it is holistic in approach as it includes all transactions
Usefulness In this accounting method, We can quickly calculate how much cash business has generated With the help of this method, We can calculate how much profit or loss has been done by a business during a particular period
Accuracy Its accuracy is doubtful as it only takes cash transactions into consideration It is far more accurate method of accounting

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