accrual accounting

Examples of accrual accounting 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.
  • An expense account is debited and a cash or liability account is credited.

• Importance of Cash Flow Accounting

  • It is usually measured during a specified, finite period of time, or accounting period.
  • 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.
  • For example, a company may be profitable but generate little operational cash (as may be the case for a company that barters its products rather than selling for cash or when its accounts receivable turnover is long).
  • In addition, cash flow can be used to evaluate the "quality" of income generated by accrual accounting.

• Recognition of Revenue Prior to Delivery

  • Accrual accounting allows some revenue recognition methods that recognize revenue prior to delivery or sale of goods.
  • The accounting principle regarding revenue recognition states that revenues are recognized when they are earned (transfer of value between buyer and seller has occurred) and realized or realizable (collection is reasonably assured).

• Current Guidelines for Revenue Recognition

  • The revenue recognition principle is a cornerstone of accrual accounting together with the matching principle.
  • They both determine the accounting period in which revenues and expenses are recognized.
  • For companies that don't follow accrual accounting and use the cash-basis instead, revenue is only recognized when cash is received .
  • The matching principle's main goal is to match revenues and expenses in the correct accounting period.
  • The principle allows a better evaluation of the income statement, which shows the revenues and expenses for an accounting period or how much was spent to earn the period's revenue.

• Expense Recognition

  • Expense recognition is an essential element in accounting because it helps define how profitable a business is in an accounting period.
  • In terms of the accounting equation, expenses reduce owners' equity.
  • Generally, cash basis accounting is reserved for tax accounting, not for financial reports.
  • 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.

• 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.
  • 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.
  • In financial accounting, assets are economic resources.

• Importance of Recognition and Measurement

  • The revenue recognition principle and the matching principle are two cornerstones of accrual accounting.
  • Related revenues as two types of accounts:
  • According to the matching principle in accrual accounting, expenses are recognized when obligations are incurred—regardless of when cash is paid out.
  • Related expenses result in the following two types of accounts:
  • 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.
  • Information enters the income statement via the accounting cycle.
  • Companies choose the length of their accounting cycle by how long it takes to carry out the required accounting—not when the individual business transactions take place.
  • 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.

• Defining Accounts Receivable

  • The accounts receivable departments use the sales ledger, which normally records:
  • Companies have two methods available to them for measuring the net value of accounts receivable, which is generally computed by subtracting the balance of an allowance account from the accounts receivable account.
  • The entry would consist of debiting a bad debt expense account and crediting the respective accounts receivable in the sales ledger.
  • Under accrual accounting, a firm can recognize revenue when it has:
  • This chart lays out methods for accruing revenue and expenses in 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.
  • To record a journal entry for a sale on account, one must debit a receivable and credit a revenue account.
  • Two methods are available to calculate the amount of bad debt expense and allowance of doubtful accounts at the end of an accounting period -- percentage of accounts receivable or percentage of sales.