There are two methods of accounting which include accrual accounting, cash accounting be the other one. This article will focus on what is accrual accounting, its type, and the advantages and disadvantages when compared to the cash account.
What is Accrual Accounting?
Accrual in financial accounting is recording the revenue earned by a firm but the payment is due and the expenses are made but the firm is yet to make the payment. The matching principle is followed in accrual accounting that demands the expense and revenue to be identified in the same period when incurred.
These types of accounting practices impact the balance sheet and income statement handling in a general way. Interest expenses and tax liabilities in the future, goodwill, assets that are based on non-cash, and liabilities affect the account.
The Definition of Accrual
Do people usually wonder what is an accrual in accounting?
If the cash payment is received at the same time the revenue is made and when all the payments are made when expenses are incurred, there will be no requirement for accruals. But, most companies need to account for unpaid revenues the next year. The same is with expenses, i.e when companies incur expenses but had not made a payment, it needs to be accrued.
Accrual Accounting Categories
Revenues and expenses, i.e receivables and payables are the broad perspectives of accruals.
1. Accrued Revenues
The assets are cash or income that has not yet been received is known as accrued revenues. The services or goods are provided in credit by the firm in such cases.
Example:
The postpaid mobile bills are paid at the end of every month after using the service. Despite having expenses during the month, the network operator waits for the month-end to generate a bill and further receive a payment.
The financial position of a company is calculated accurately because of accrual revenues. There is an increase in the cash account and a decrease in receivables when the company receives money from its clients or debtor at month-end.
2. Accrued Expense
The firm makes a purchase on credit and the general ledger shows liability, it acknowledges the creditor’s obligations. In accounting terms, one can say it means that the payment has not yet been made but expenses have been incurred.
The accrued expenses that are common includes:
– Interest expense accruals
-Supplier accruals
-Salary or wages accrual
Example:
A commission is earned by a salesperson immediately on selling a product. The commission earned by the person is regarded as an expense at the very instance even though it would be paid in the next accounting year. The company’s current year income statement would reflect expenses and the accrued commission will be reflected on the balance sheet of the next year.
Merits and Demerits of Cash Accounting v/s Accrual Accounting
