Accrual Accounting

What is Accrual Accounting?

Accrual accounting is an accounting method that records revenues when they are earned and expenses when they are incurred, regardless of when cash is received or paid. This approach follows the matching principle, ensuring that income and the related expenses are recognised in the same accounting period.

Why is accrual accounting important?

Accrual accounting is important because it provides a more accurate picture of a business's financial performance. It records revenues and expenses in the accounting periods to which they relate, enabling businesses to measure profitability more reliably and compare performance across reporting periods.

It also improves the accuracy of financial statements, supports budgeting and forecasting, and helps businesses comply with generally accepted accounting principles (GAAP), International Financial Reporting Standards (IFRS), and other applicable accounting regulations.

How does accrual accounting work?

Accrual accounting recognises revenue when it is earned and expenses when it is incurred, regardless of when the related cash transactions occur.

1. Recording revenue

Revenue is recorded when goods are delivered or services are provided, even if the customer pays at a later date.

2. Recognising expenses

Expenses are recognised when they are incurred to generate revenue, even if payment is made in a future accounting period.

3. Recording receivables and payables

If cash has not yet been received, the business records an accounts receivable. Similarly, if an expense has been incurred but not yet paid, it is recorded as accounts payable.

4. Preparing financial statements

At the end of the accounting period, all recognised revenues, expenses, assets and liabilities are reflected in the financial statements to present an accurate view of the business's financial performance and position.

5. Receiving or paying cash

When cash is eventually received from customers or paid to suppliers, the business settles the related receivable or payable without affecting the revenue or expense already recognised.

Example

A consulting firm completes a project worth ₹1,50,000 in March and issues an invoice to the client. The client pays the invoice in April.

Under accrual accounting, the business records ₹1,50,000 as revenue in March because the service was provided during that month. When the payment is received in April, the business reduces its accounts receivable without recording the revenue again.

Similarly, if the business receives an electricity bill in March but pays it in April, the expense is recognised in March because it relates to that accounting period.

Key points to remember

• Accrual accounting records revenues when they are earned and expenses when they are incurred.
• It provides a more accurate measure of profitability than cash accounting.
• Accounts receivable and accounts payable are commonly used in accrual accounting.
• Most medium and large businesses use accrual accounting to prepare financial statements.
• The method supports compliance with accounting standards such as GAAP and IFRS.