Accounting is essential for corporations, enterprises, and industries. The types of accounting include cost accounting, managerial accounting, financial accounting, tax accounting, etc. Here, you will be reading about accrual-based accounting, whose prime purpose is to provide you with the actual picture of the organization’s financial standing.
- Accrual accounting is based on recording expenses and revenue before the actual transaction.
- Accrual-based accounting shows a real and exact picture of a company’s financial position.
- It is essential to estimate the future financial performance with greater accuracy to make wise business decisions.
- In contrast, cash accounting simplifies bookkeeping as it computes revenue and expense after payment.
What Is Accrual-Based Accounting| An Introduction?
When running a business, you will encounter two accounting techniques, i.e., cash accounting and accrual-based accounting. Let’s discuss these and determine which is more suitable for an organization.
The accounting system, known as accrual-based accounting, or simply accrual accounting, measures, and records expenses and revenues at the moment of delivery or service provision, regardless of when payment is received. It acts in accordance with the matching principle.
Whereas if you talk about cash, accounting measures transactions at the time of payment. Most people consider the cash accounting method easy, but they know about the great advantage of accrual-based accounting.
What is the purpose of accrual-based accounting?
Accrual-based accounting aims to give a more comprehensive portrayal of a company’s financial health and economic situation by allocating revenues and expenses to the periods. They are generated or spent rather than the periods when the related cash flows take place.
Moreover, accrual-based accounting offers a consistent method of documenting financial transactions, making comparing businesses, sectors, and time periods simpler. It makes it simpler for stakeholders and investors to assess a company’s financial situation and potential for growth.
Accrual-based accounting aims to give business owners a more accurate and thorough picture of their financial performance, which is crucial for successful decision-making and long-term growth.
How Is Accrual-Based Accounting Carried Out?
Accrual accounting is famous in sales, good service providers, and enterprises. The procedure of accrual-based accounting is as follows:
- The First Step Is Recording the Revenue
The time a sale is made, not when payment is received, is the time that revenue is recorded. When a business sells something on credit to a customer, the sale is recorded as income at the time of the sale, even if the cash is not received until a later date.
- The Second Step Is Recording Expenses
It is recorded when an expense is incurred, not when the cash is paid. If a business makes a credit purchase of goods but doesn’t pay for them immediately, the expense will be recorded when the goods are received.
- The Third Step Is Accruing Revenue
Accrued revenue occurs when a business renders a service or sells goods but has not yet been paid. In other words, the revenue is counted as earned even though the money hasn’t arrived yet.
- The Fourth Step Is Accruing Expenses
A business has incurred an accumulated expense but has not yet been paid for. In other words, the expense is considered incurred even if payment has not yet been made.
- The Fifth Step Is Adjusting Entries
Adjusting entries are done at the close of an accounting period (often monthly or annually) to verify that the books appropriately represent the period’s income and expenditures. Accruals, prepayments, and depreciation are all examples of possible journal entries.
- The Sixth Step Is Closing the Books
When the closing entries have been made, the accounting books are closed for the period. The books are now prepared for the following accounting period, with all revenue and costs having been recorded.
If a business follows these procedures, it can keep accurate financial records even if the instant cash exchange is delayed. So the corporation can make more informed financial judgments.
The Bottom line
Accrual accounting will be the most real image of your business. Moreover, accrual accounting is your answer if you are a wholesaler or retailer. It is advantageous as it gives deeper insight into the financial position of your organization.
Joseph Salvatore is a content writer who has worked for a business licensing NYC company since he started his career. He is 38 years old, but his love for writing never decreases in all these years. Besides loving his career, he loves his toddler and wife.