Accrual Accounting Definition: Guide to Accrual Accounting

Accrual accounting is an accounting method that documents and measures a company’s revenue and expenses when they occur, rather than when cash changes hands. The accrual accounting system is the opposite of cash accounting, another accounting method that only records financial transactions once payment has occurred. Accrual accounting is the generally accepted accounting principle (GAAP) used by large companies, as it gives a more accurate picture of a company's liquidity and current assets and liabilities.

Accrual accounting works by measuring a company's current and expected revenues against its current and expected expenses during a given accounting period. Accrual accounting incorporates revenue for services that have been rendered or inventory that has been exchanged, even if the company hasn’t received cash payment yet. It documents expenses in the same way. These things are typically recorded on a balance sheet through accounts payable or accounts receivable.

Here are some of the potential benefits of using this method of accounting.

1. 1. Offers a detailed picture of your company’s finances. Accrual accounting is the standard accounting method for large businesses because it offers a detailed, long-term picture of a company's financial position.
2. 2. It considers your most up-to-date expenses. Accrual accounting gives an accurate, current picture of your company’s financial standing by incorporating the most recent revenue and expenses into a company’s cash flow. Clients who have come to a company for services but pay late will not affect the company’s financial statements.
3. 3. It helps companies transition from small to large. Companies that make more than $25 million annually are required to use accrual accounting, while small businesses can choose which accounting method to use. If a small business has plans of growing, using accrual accounting from the beginning eliminates having to adjust to the accrual method eventually.

Here are some of the potential disadvantages of accrual accounting, some of which include the following.

1. 1. It can be complicated to track. Accrual accounting is a more complex method of accounting than simple cash accounting. Tracking unpaid invoices and expenses can take more time and resources than simple cash accounting.
2. 2. It can inflate a company’s short-term financial standing. The accrual method of accounting can give a slightly false impression of a company's short-term financial position. If there are a large number of accounts receivable on a balance sheet that have yet to be paid, it may appear as if your company has more finances to cover expenses than it actually has in cash.
3. 3. It doesn’t always accurately indicate cash flow. A company’s revenue in accrual accounting relies on the timely payment of bills, which they can’t always control. If clients pay their bills late and the company doesn’t have as much cash available as they expected to, this can affect the company’s ability to pay its own bills.

There are two main accounting methods: accrual accounting and cash accounting. The cash accounting method only considers cash transactions but not pending financial transactions in its bookkeeping. This means that revenue is only accounted for when cash enters a company’s bank account.

The accrual basis of accounting considers all financial transactions, including pending transactions. The IRS allows small business owners to choose which accounting method they prefer, while larger businesses earning over $25 million in a tax year are required to use accrual accounting to determine their financial health.

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