Simple Explanation of Accrual Basis Accounting
Definition
Accrual basis is the accounting method that recognizes and records revenues and expenses in the period they occur. It is different from cash basis which revenues are only recorded when cash is received and, expenses are recorded when cash is paid.
Accrual Basis for Revenues
In the accrual basis, a company recognizes revenues when goods are delivered or services are provided regardless of when the company will receive the payment. That is why there usually is account receivable on the balance sheet in the company that uses accrual basis.
Accrual Basis for Revenues Example
On 22 December 2018 ABC Co. sold $500 goods on credit to one of its customers. The goods cost $300 in the inventory.
The accounting entry of the transaction on 22 December 2018 was:
| Account | Debit | Credit |
|---|---|---|
| Accounts receivable | 500 | |
| Sales | 500 | |
| Cost of goods sold | 300 | |
| Inventory | 300 |
In the example above, there was no cash transaction involved; however, in accrual basis, ABC Co still recorded sales as it occurred and in the period it occurred.
Accrual Basis for Expenses
In accrual basis, the company recognizes expenses when it receives goods or services from its suppliers regardless of when the company made the payment to the suppliers. That is why there usually is account payable on the balance sheet in the company that uses accrual basis.
Accrual Basis for Expenses Example
On 19 December 2018 ABC Co. bought $150 office supplies on credit from one of its suppliers.
The accounting entry of the transaction on 19 December 2018 was:
| Account | Debit | Credit |
|---|---|---|
| Office supplies expense | 150 | |
| Accounts payable | 150 |
In the example above, there was no cash transaction involved; however, in accrual basis, ABC Co still recorded expense as it occurred and in the period it occurred.
Benefits of Accrual Basis
The matching principle which records revenues and all related expenses in the same period as they occurred only exists in the accrual basis. This is due to in the cash basis the revenues are recognized only when cash is received and the expenses are recognized only when cash is paid.
The accrual basis provides a more realistic view of the revenues and expenses that the company has than the cash basis. Therefore, it provides a better picture in evaluating the result of the company’s operation during a period of time.
In addition, only accrual basis is allowed under IFRS or US GAAP; cash basis is not allowed.
It is useful to note that on the accrual basis, the increase or decrease of cash does not necessarily determine the net income of the company.