Accrual Accounting

Beginner

Accrual accounting records income when it is earned and expenses when they are incurred, regardless of when cash actually changes hands.

Under accrual accounting, the timing of cash does not decide when something is recorded. A sale is recorded when the goods are delivered or the service is performed, even if the customer pays later. An expense is recorded when the business uses the service or receives the goods, even if the bill is paid next month.

Suppose a consultant completes a 5,000 project in December but is paid in January. Under accrual accounting, the 5,000 is revenue for December, because that is when it was earned. The money owed is recorded as accounts receivable until it arrives.

This approach gives a truer picture of a business's performance in each period, because income is matched with the costs of earning it. It is required for most companies under GAAP and IFRS.

The downside is that profit and cash can differ significantly. A fast-growing business might report strong profits while running short of cash, because customers have not yet paid. That is why financial statements include a cash flow statement alongside the income statement.

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