Harness Money

What is accrual accounting?

Accrual accounting is an accounting method that recognizes revenues and expenses when they are earned or incurred, regardless of when the actual cash is received or paid. It focuses on recording transactions at the time they occur, rather than when the associated cash flows take place.

In accrual accounting, revenue is recognized when it is earned, meaning when goods are delivered or services are performed, and there is a reasonable expectation of payment. Similarly, expenses are recognized when they are incurred, even if the payment for those expenses is made at a later date.

The key principle of accrual accounting is the matching principle, which aims to match revenues with their related expenses in the same accounting period to provide a more accurate representation of a company’s financial performance.

Accrual accounting requires the use of two fundamental accounting concepts: accruals and deferrals.

1. Accruals: Accruals involve recognizing revenues or expenses before the associated cash flows occur. For example, if a company provides services to a client in December but doesn’t receive payment until January, the revenue is recognized in December when the services were provided.

2. Deferrals: Deferrals involve recognizing revenues or expenses after the related cash flows occur. For instance, if a company receives payment in advance for services to be provided in the future, the payment is recorded as a liability (unearned revenue) until the services are rendered, at which point the revenue is recognized.

Accrual accounting provides a more comprehensive view of a company’s financial position and performance compared to cash basis accounting, as it considers all economic activities, regardless of cash movements. It is the preferred method of accounting for most businesses, particularly those that need to adhere to generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS).