how accrual accounting works
the general concept of accrual accounting is that accounting journal entries are made when a good or service is provided rather than when payment is made or received entries are also made for debts and payments due this method allows the current and future cash inflows or outflows to be combined to give a more accurate picture of a company s current and long term finances accrual accounting follows the matching principle which states that revenues and expenses should be recorded in the same period accrual accounting is encouraged by international financial reporting standards ifrs and generally accepted accounting principles gaap as a result it has become the standard accounting practice for most companies except for very small businesses and individuals larger companies are required to use the accrual method of accounting if their average gross receipt of revenues is more than 25 million over the previous three years if a company does not meet the average revenue requirement it can choose to use cash basis or accrual as its accounting method 12accrual accounting is always required for companies that carry inventory or make sales on credit regardless of the company size or revenue 3benefits of accrual accountingthe accrual method does provide a more accurate picture of the company s current condition but its relative complexity makes it more expensive to implement this method arose from the increasing complexity of business transactions and a desire for more accurate financial information selling on credit and projects that provide revenue streams over a long period affect a company s financial condition at the time of a transaction therefore it makes sense that such events should also be reflected in the financial statements during the same reporting period that these transactions occur under accrual accounting firms have immediate feedback on their expected cash inflows and outflows making it easier for businesses to manage their current resources and plan for the future accrual accounting provides a more accurate picture of a company s financial position however many small businesses use cash accounting because it is less confusing accrual accounting vs cash accountingaccrual accounting can be contrasted with cash accounting which recognizes transactions only when there is an exchange of cash additionally cash basis and accrual differ in the way and time transactions are entered cash accounting uses transactions when payments are made for example consider a consulting company that provides a 5 000 service to a client on oct 30 the client received the bill for services rendered and made a cash payment on nov 25 under the cash basis method the consultant would record an owed amount of 5 000 by the client on oct 30 and enter 5 000 in revenue when it is paid on nov 25 and record it as paid in contrast accrual accounting uses a technique called double entry accounting when the consulting company provided the service it would enter a debit of 5 000 in accounts receivable debits increase an asset account when the payment is made on nov 25 the consultant credits credits decrease an asset account the accounts receivable by 5 000 and credits the service revenues account a revenue account credits increase a revenue account with 5 000 the received capital can then be moved to other accounts such as free cash if needed the company uses the same double entry method to enter which account the capital came from and is moved to 