Accrual concept is also termed as the accrual principle. It is also known as accrual basis of the accounting revenues as well as expenses which are recorded in the books of accounts right when they are incurred or earned. And this is not when they are paid or received in cash. There are certain events of business that are captured in the accounting system when they are happening. And this is not when the cash flows in or out in multiple cases where the timings of the cash flows happen to be different from the particular time right when the transactions occur. In case you wait for the cash, then the recording might get delayed and there would be a possibility that it would either just get recorded in various period of time or it would have no such relevance until you record the transaction for certain economic decisions.
Everything about Accrual Concept:
The contrast to the accruals basis of accounting is the cash basis of that accounting that records the transactions when the cash flows in or even out. As a matter of fact, there are certain differences between cash basis accounting and accrual basis accounting. In this guide, while you won’t be aimed at getting enlightened about the aforementioned factor, you would definitely be familiar with everything about the accrual concept.
There are multiple accounting frameworks around the globe which suggest that using the accrual and the concept happens to be one of the most fundamental assumptions for preparing for the financial statements in a total of two of the most widely used frameworks of accounting, for example, the IFRSs and US GAAP. The reason happens to be accrual basis of the accounting and it also helps in providing a more accurate view of the financial position of the entity as well as financial performance. So, you can safely say that the accrual basis also helps in providing more accurate information concerning the revenues that are earned and expenses incurred during the period. In addition to that, it also affects the transactions too. The examples have been given right below. To know more, keep reading on.
According to the example, the credit sale is made to the one customers that are worth a total of 5000 just in the month of July. As a matter of fact, the customer also promised to make the respective payments by the end of next month, which is in the month of August.
In case the recording of that 5000 gets delayed until the next month, i.e. August, then the cash actually is received then and it will not give the appropriate view of that particular business. There must be certain reasons behind this. In case you wish to know more, keep reading on.
- According to the first reason, the sales revenue will be understated by a total of 5000 due to the entity earning the income. It is only that the cash has not reached the entity against the sale. In short, incomes happen to be understated.
- As a matter of fact, the entity’s asset will be understated, for the entity already has the right to receiving cash of about 5000 which is receivable from the customer. The fact is that the receivable or the debtors are the assets of the organization for they owe the given money to this.
The other example of this is of the expenses such as rentals, electricity bills, salary expenses, as well as rentals. The rentals are similarly reported as the expense when they fall due. When you want to understand these drawbacks of the cash basis accounting, the accounting frameworks always require the financial statements to get prepared on the accrual basis, for it happens to be critical to the understanding of the users. In addition to that, this also requires acquiring relevant information.
There’s a point that you would always need to remember irrespective of everything else. Any accounting framework that needs special purpose financial statements can also require various examples of some industries in multiple countries. These also require preparing the accounts on a cash basis. As a matter of fact, under any given circumstances the accounting framework might also require preparing the financial statements on different scenarios. For instance, in case the entity is no more going concern then the financial statements are prepared on the breakup basis which might or might not allow for the accruals.
The examples have been mentioned here.
- If the credit sales customers are given the allowance of paying after some times then sales get recorded when the sales happen actually. After then, the cash gets received within a total of 30 to 60 days.
- Almost every time, the employees are paid right on the month’s fifth day for their previous month’s work. So the compensation of about 1,000 for January is paid right in the month of February and on 5. Nevertheless, in case the financial statements for this month are prepared 1,000, then it will be recorded as it gets incurred in the month of January instead of February.
- The educational institutes always ask for the tuition fees which they expect to get in advance to them. As a matter of fact, this happens to be the income that is received in advance by the Institute and it will be recorded as the liability. For instance, in case a total of 60% course gets completed then 60 percent of the total amount will be received in advance. Plus, it will be treated as the income and the rest is still presented as the liability in the statements of finance.
- The next thing is that the utility bills such as electricity bill for January may have the due date that can fall in the month of February. However, it is recorded at the receipt’s date in case it is received within January. The due date happens to be the date when the bill is paid and not the date when the expense is supposed to be incurred.
Thus compiles everything to know about accrual concept.
Krishna Murthy is the senior publisher at Finance XOD. He is not only the senior publisher but also the owner of Tricky Finance. Krishna Murthy was one of the brilliant students during his college days. He completed his education in MBA (Master of Business Administration), and he is currently managing the all workload for sharing the best banking information over the internet. The main purpose of starting Tricky Finance is to provide all the precious information related to businesses and the banks to his readers.