What Is Accrual Basis?
The basis of accrual accounting is a form of accounting that records financial and economic events as they happen rather than when they are paid or received. This means that revenue and expenses are recorded in the financial accounts when they are generated or incurred rather than when they are paid or received.
Or,
Accrual basis is in the context of accounting, practice in which expenses and income are accounted for as if they are earned or incurred, whether or not they have been received or paid. Antithesis of cash basis accounting.
Understanding the Term Accrual Basis
Warren Buffett has been quoted as saying, "Accrual accounting is a more sophisticated method of accounting than cash accounting, as it takes into account the timing of transactions and provides a better understanding of a company's financial performance and obligations."
Accrual basis accounting is a way of documenting transactions based on the accrual accounting concept, which stipulates that revenue is recognized when the sales occur, and costs are recognized when they are incurred. This strategy produces a more realistic picture of a company's financial performance because it shows financial obligations and earnings as they occur rather than when payment is received or made.
In accrual basis accounting, a company's financial performance and liabilities are more accurately reflected, allowing for a better knowledge of its financial condition and more accurate financial forecasting.
Advantages of Accrual Basis Accounting
Rather than using cash basis accounting, using accrual basis accounting offers more advantages, including:
- Gives a clear picture of the business’s financial position and health.
- Assist in matching revenue and expense for the accounting period.
- Accurately shows the timing of transactions and gives a complete understanding of the business’s income.
- Allow the business to create accurate and sophisticated financial budgets and forecasts.
- Increases financial statement consistency by requiring organizations to use the same accounting rules.
Examples
International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) endorse accrual accounting (GAAP).
Example 1
Suppose a business sold a product to a customer in March and received the payment in April. Under the accrual basis of accounting, that transaction would be recorded in March at the time of that economic event.
Example 2
Suppose that a company entered into a contract to provide service in May. Under the accrual basis of accounting, the company would record the economic event when the service is provided rather than when the payment is received.
In Sentences
- Accrual accounting records a business's financial events and earnings as they occur.
- Accrual accounting gives a more precise portrayal of a business's financial health and performance.