What Is Accrual Basis of Accounting and How Does It Work?

Posted In | Finance | Accounting Software

Accrual basis accounting is a method of accounting that focuses on recognizing revenues and expenses when they are earned or incurred, rather than when they are paid. This means that revenues are recognized when goods or services are delivered to a customer, rather than when payment is received, and expenses are recognized when they are incurred, rather than when they are paid.

 

 

Example of Accrual Basis in Accounting

To illustrate how the accrual basis of accounting works, let's consider an example. If a company provides a service to a customer on December 1 and sends an invoice for the service on December 15, the revenue from that service would be recognized in the accounting records on December 1, the date the service was provided, rather than on December 15, the date the invoice was sent. Similarly, if a company incurs expenses on November 30 but doesn't pay for them until December 15, the expenses would be recognized in the accounting records on November 30, the date they were incurred, rather than on December 15, the date they were paid.

 

Difference Between Accrual Basis and Cash Basis

The cash basis of accounting is simpler and more intuitive. It does not provide a complete picture of a business's financial performance and is not in compliance with generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS).

 

The accrual basis of accounting is considered to be more accurate and provides a more complete picture of a business's financial performance. This is because it takes into account not only the cash inflows and outflows, but also the revenues and expenses that have been earned or incurred but not yet received or paid.

 

Advantages of Accrual Basis of Accounting

1. Accrual basis accounting provides a more accurate picture of a company's financial performance and company's profitability because it takes into account all of the company's revenues and expenses, regardless of when they are paid or received. 
2. Accrual basis accounting provides more information to decision-makers, which can help them to make more informed decisions. For example, accrual basis accounting provides information about a company's accounts receivable and accounts payable, which can help decision-makers to assess the company's financial health and make decisions about how to manage its cash flow.
3. Accrual basis accounting is required by generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), so companies that use accrual basis accounting can be assured that their financial statements are in compliance with these standards. This can be important for companies that need to provide financial statements to stakeholders, such as investors, creditors, and regulatory agencies.

 

Disadvantages of the Accrual Basis of Accounting

There are also some disadvantages to using the accrual basis of accounting, including the following: 

1. Accrual basis accounting can be more complex than cash basis accounting because it requires tracking and recognizing revenues and expenses when they are earned or incurred, rather than when they are paid or received. This can require more record-keeping and can be more difficult for some companies to manage. 
2. Accrual basis accounting can sometimes provide a less accurate picture of a company's short-term cash flow. Because it recognizes revenues and expenses when they are earned or incurred, rather than when they are paid or received, accrual basis accounting may not always reflect the actual cash inflows and outflows of the business in the short term. 
3. Accrual basis accounting can sometimes be less transparent than cash basis accounting. Because it involves recognizing revenues and expenses in different periods than when they are paid or received, accrual basis accounting can sometimes be less intuitive and may be more difficult for stakeholders to understand. 
4. Accrual basis accounting can be more susceptible to errors and manipulation than cash basis accounting. Because it involves recognizing revenues and expenses in different periods than when they are paid or received, there is more opportunity for errors and manipulation in accrual basis accounting. This can make it more important for companies to have strong internal controls and to regularly review and reconcile their financial records.

 

How can Gridlex Sky Accounting Software help to Manage Accrual Basis Efficiently? 

Gridlex Sky Accounting software can help to manage accrual basis accounting by automating many of the tasks involved in tracking and recording revenues and expenses. This can include generating invoices and tracking accounts receivable, as well as tracking accounts payable and generating reports on a company's financial performance.

 

For example, when a company provides a service to a customer, Gridlex Sky accounting software can automatically generate an invoice for the service and record the revenue in the appropriate account. This eliminates the need for manual record-keeping and ensures that all of the company's revenues are accurately reflected in the financial records.

 

Similarly, when a company incurs expenses, Gridlex Sky can automatically track those expenses and record them in the appropriate accounts. This can include monitoring the payment of bills and recording the expenses in the appropriate accounts.

 

Frequently Asked Questions: 

1. What are the disadvantages of accrual basis accounting? 

The disadvantages of accrual basis accounting include the potential for increased complexity, a less accurate picture of short-term cash flow, less transparency, and greater susceptibility to errors and manipulation.

 

2. How does accrual basis accounting differ from cash basis accounting? 

Accrual basis accounting is different from cash basis accounting in that it recognizes revenues and expenses when they are earned or incurred, rather than when they are paid or received. This means that accrual basis accounting takes into account all of a company's revenues and expenses, regardless of when they are paid or received, whereas cash basis accounting only recognizes revenues and expenses when they are paid or received.

 

3. Why is accrual basis accounting used? 

Accrual basis accounting is used because it provides a more accurate and complete picture of a company's financial performance. It recognizes revenues and expenses when they are earned or incurred, rather than when they are paid or received, which provides more useful information for decision-making and is required by generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).