One of the critical responsibilities of business owners and accountants is selecting an accounting technique to record transactions. Accrual-based accounting is one of two major accounting procedures and the most often used bookkeeping approach for obtaining an accurate financial picture of a company’s operations. When financial reports are prepared under the Generally Accepted Accounting Principles, the accrual foundation of accounting must be used.
Accrual-based accounting is the concept in which transactions and events are recognized or reported as they happen not when cash is received or paid, as compared to cash basis accounting in which transactions are recognized or reported only when cash is received or paid. This method follows the accrual principle which states that revenues and expenses should be recognized in the same period.
The concept of the accrual basis of accounting can be summarized as;
Accrual accounting consists of two principles. The two principles are part of the generally accepted accounting principle (GAAP).
Revenue recognition principle: According to the revenue recognition principle, you should only record income when earned, not when you receive associated cash.
Matching principle: According to the matching principle, you should match related revenues and expenses in the same period. This theory emphasizes that in order to generate revenue, companies must incur expenses.
There are various types of accrual accounts. The most common include accrued revenues and accrued expenses.
Accrued Revenues are revenues collected by a corporation in the normal course of business after selling a product or providing services to the customer for which payment has not yet been received. It follows the generally accepted accounting principle (GAAP) which specified that it doesn’t matter whether you receive cash at the time, revenue is recognized when a customer takes ownership of a good or receives a service.
The purpose of an accrued revenues journal entry is to recognize the revenues
Let’s say company XYZ has a consulting project with a large client, under which the consulting agreement clearly delineates a milestone, in which the client owes $12,000 to the company at the end of the project. The milestone is for the month of January, the company must create the following journal entry to record the revenues:
|Account receivable/Accrued revenue
At the end of the next month, the XYZ company completes the milestone and bills the client for $12,000. On the day when clients paid to the company, cash will debit, and accrue revenue will credit. The company will create the following journal entry:
|15th March 2022
|Account receivables/Accrued revenue
The term “accrued expense” refers to a cost that has already been incurred but for which payment has not yet been paid.
The purpose of accrued expenses journal entry is to recognize the expenses that the company incurs over a period of time but are unpaid by the company.
Let’s say a company XYZ purchased goods worth $8,000 from Hamdan limited on the 31st of January 2022 but didn’t pay for it at the time of purchase. As per the matching principle, XYZ company will record the expenses of $8000 in the financial year ending on 31st January 2022, even though they receive the payment in the next accounting period.
|31st January 2022
The accounting entry on the day of payment, let’s say 10th march 2022 will be debit accounts payable and credit cash. The company will record the following journal entry.
|10th march 2022
|Accounts Payables/Accrued expenses