Accrual Accounting

By: Syed Talha Zafar

Introduction

• Accrual accounting is an accounting method whereby revenue and expenses are recorded in the periods in which they are incurred.

• Accrual accounting is the opposite of cash accounting, which recognizes economic events only when cash is exchanged.

• Most businesses typically use one of two basic accounting methods in their bookkeeping systems: cash basis or accrual basis. While most businesses use the accrual basis, the most appropriate method for your company depends on your sales volume, whether or not you sell on credit and your business structure.

Example

• let's take a Company STZ must insure one of its buildings. The insurance company bills STZ of Rs.6000 every six months (one bill in January, the next in July). If each bill is for six months of coverage, then under the accrual method, STZ would not record a Rs.6000 expense in January and a Rs.6000 expense in July (doing so would mean STZ was using the cash method); it would instead record a Rs.1000 expense each month for the whole year. That is, Company STZ would match the expense to the period in which it was incurred: Rs.1000 for January, Rs.1000 for February, Rs.1000 for March, and so on.

• A company sells a TV to a customer who uses a credit card, cash and accrual methods will view the event differently. The revenue generated by the sale of the TV will only be recognized by the cash method when the money is received by the company. If the TV is purchased on credit, this revenue might not be recognized until next month or next year.

Why it Matters• Accrural method is more complex, harder to implement,

and harder to maintain than the cash method of accounting, most analysts agree that accrual accounting gives a more accurate picture of a company's performance. That's because in any given accounting period, revenues are associated with their corresponding expenses, which gives a perfect picture of the real costs of generating revenue in a given period.

difference between the cash basis and the accrual basis

Under the accrual basis of accounting...• Revenues are reported on the income statement when they are earned—

which often occurs before the cash is received from the customers.• Expenses are reported on the income statement in the period when they

occur or when they expire—which is often in a period different from when the payment is made.

Under the cash basis of accounting...• Revenues are reported on the income statement in the period in which the

cash is received from customers.• Expenses are reported on the income statement when the cash is paid out.

Advantage and disadvantages of accrual and cash

• Advantages and disadvantages of the cash based accounting method:  the cash method is simple to implement by just tracking the cash flow and provides an accurate representation of cash activities. However, it is not a good method to measure long term profitability as it does not recognize receivables and payables. It is possible that the company is earning a profit with cash method but in fact it is losing money.

• Advantages and disadvantages of accrual accounting method: the accrual method shows the income and debts more accurately but loses track of cash flow which may result in a serious cash flow problem. It is also more complicated and expensive to employe than the cash method.

Conclusion & Recommendation