accrual

Examples of accrual in the following topics:

• Differences Between Accrual-Basis and Cash-Basis Accounting

  • Accrual accounting does not record revenues and expenses based on the exchange of cash, while the cash-basis method does.
  • Under the accrual accounting method, the receipt of cash is not considered when recording revenue; however, in most cases, goods must be transferred to the buyer in order to recognize earnings on the sale.
  • An accrual journal entry is made to record the revenue on the transferred goods even if payment has not been made.
  • In this case, an accrual entry for revenue on the sale is not made until the goods are delivered or are in transit.
  • The cash-basis method, unlike the accrual method, relies on the receipt and payment of cash to recognize revenues and expenses.

• Terminology of Accounting

  • Important terminology in accounting includes cash vs. accrual basis, assets, liabilities, and equity.
  • There are two primary accounting methods - cash basis and accrual basis.
  • In contrast, the accrual method records income items when they are earned and records deductions when expenses are incurred, regardless of the flow of cash.
  • Accrual accounts include, among others, accounts payable, accounts receivable, goodwill, deferred tax liability and future interest expense.
  • The term accrual is also often used as an abbreviation for the terms accrued expense and accrued revenue.

• Expense Recognition

  • Most financial reporting in the US is based on accrual basis accounting.
  • Under the accrual system, an expense is not recognized until it is incurred.

• Importance of Recognition and Measurement

  • The revenue recognition principle and the matching principle are two cornerstones of accrual accounting.
  • According to the matching principle in accrual accounting, expenses are recognized when obligations are incurred—regardless of when cash is paid out.
  • The matching principle is a culmination of accrual accounting and the revenue recognition principle.

• Impact of the Operating Cycle on the Income Statement

  • The accrual method ensures proper reporting on the income statement because the operating cycle doesn't coincide with the accounting cycle.
  • To allow for the fluctuations in the operating cycle, many companies choose to use the accrual basis of accounting.
  • In accrual accounting, companies recognize revenues when the company makes a sale or performs a service, regardless of when the company receives the cash.

• Recognition of Revenue Prior to Delivery

  • Accrual accounting allows some revenue recognition methods that recognize revenue prior to delivery or sale of goods.

• Current Guidelines for Revenue Recognition

  • The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle.
  • For companies that don't follow accrual accounting and use the cash-basis instead, revenue is only recognized when cash is received .

• Importance of Cash Flow Accounting

  • Cash flow is often used as an alternative measure of a company's profitability when it is believed that accrual accounting concepts do not represent economic realities.
  • In addition, cash flow can be used to evaluate the "quality" of income generated by accrual accounting.

• Recognizing Accounts Receivable

  • If you are operating under the accrual basis, you record account receivable transactions irrespective of any changes in cash.
  • Assuming Furniture Palace uses the accrual method of accounting, a journal entry is recorded for the sale of the item and the extension of credit to the customer.
  • If you are operating under the accrual basis, you record transactions irrespective of any changes in cash.

• The Importance of Timing: Revenue and Expense Recognition

  • Accounting standards require that companies using the accrual basis of accounting and match all expenses with their related revenues for the period, so that the income statement shows the revenues earned and expenses incurred in the correct accounting period.
  • The matching principle, part of the accrual accounting method, requires that expenses be recognized when obligations are (1) incurred (usually when goods are transferred, such as when they are sold or services rendered) and (2) the revenues that were generated from those expenses (based on cause and effect) are recognized.