Accrual Accounting

AAA

DEFINITION of 'Accrual Accounting'

An accounting method that measures the performance and position of a company by recognizing economic events regardless of when cash transactions occur. The general idea is that economic events are recognized by matching revenues to expenses (the matching principle) at the time in which the transaction occurs rather than when payment is made (or received). This method allows the current cash inflows/outflows to be combined with future expected cash inflows/outflows to give a more accurate picture of a company's current financial condition.

INVESTOPEDIA EXPLAINS 'Accrual Accounting'

Accrual accounting is considered to be the standard accounting practice for most companies, with the exception of very small operations. This method provides a more accurate picture of the company's current condition, but its relative complexity makes it more expensive to implement. This is the opposite of cash accounting, which recognizes transactions only when there is an exchange of cash.

The need for this method arose out of 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 of time affect the company's financial condition at the point of the transaction. Therefore, it makes sense that such events should also be reflected on the financial statements during the same reporting period that these transactions occur.

For example, when a company sells a TV to a customer who uses a credit card, cash and accrual methods will view the event differently. The revenue generated by the sale of the TV will only be recognized by the cash method when the money is received by the company. If the TV is purchased on credit, this revenue might not be recognized until next month or next year.

Accrual accounting, however, says that the cash method isn't accurate because it is likely, if not certain, that the company will receive the cash at some point in the future because the sale has been made. Therefore, the accrual accounting method instead recognizes the TV sale at the point at which the customer takes ownership of the TV. Even though cash isn't yet in the bank, the sale is booked to an account known in accounting lingo as "accounts receivable," increasing the seller's revenue.

For more on Accrual Accounting and other accounting basics, check out our Accounting Basics Tutorial.

VIDEO

Loading the player...
RELATED TERMS
  1. Accounting Postulate

    A fundamental assumption in the field of accounting. Like any ...
  2. Accrual Swap

    A form of discrete time-switch option in which the interest on ...
  3. Dollar-Value LIFO

    An accounting method used for inventory that follows the last ...
  4. Appraisal Method Of Depreciation

    A form of depreciation calculation that is based upon appraisal ...
  5. Nonaccrual Experience Method - ...

    An accounting procedure allowed by the Internal Revenue Code ...
  6. Ratable Accrual Method

    A method for determining when and how much income was earned ...
RELATED FAQS
  1. What does it mean when airline revenues are adjusted for air traffic liability?

    Airline revenue adjustments for air traffic liability are simply part of the accrual accounting method that airlines commonly ... Read Full Answer >>
  2. How can I set up an accrual accounting system for a small business?

    First, determine whether accrual accounting makes the most sense practically and financially. If the small business is also ... Read Full Answer >>
  3. Can unearned rent be considered deferred revenue?

    Unearned rent can be considered deferred revenue from the perspective of a landlord or rental company, if that landlord or ... Read Full Answer >>
  4. What are some examples of deferred revenue becoming earned revenue?

    Deferred revenue represents payments received by a company in advance of delivering its goods or performing its services. ... Read Full Answer >>
  5. What is the indirect method of calculating cash flow from operating activities?

    The indirect method of calculating cash flow from operating activities calculates a company's cash flow from operations by ... Read Full Answer >>
  6. What is the difference between an accrual and an account payable?

    The difference between an accrual and an account payable is that an accrual is an accounting adjustment for revenue that ... Read Full Answer >>
  7. When is accrual accounting more useful than cash accounting?

    The accrual accounting method is more useful than the cash accounting method when a person or company is trying to understand ... Read Full Answer >>
  8. What types of companies tend to have the most deferred revenue?

    The types of companies that tend to have the most deferred revenue are those that accept high amounts of payments prior to ... Read Full Answer >>
  9. What is the difference between cash flow and revenue?

    Revenue is the money a company takes in from conducting its regular business operations. Cash flow refers to available cash ... Read Full Answer >>
  10. What types of revenue are taxable?

    Essentially, all the various types of business revenue are taxable. A company's revenue is the total amount of money or value ... Read Full Answer >>
  11. What is accrual accounting used for in finance?

    Accrual accounting is also known as the accrual basis, or accrual method, of accounting. Its basic premise holds that transactions ... Read Full Answer >>
  12. What is the difference between accrual accounting and cash accounting?

    The primary difference between the two principal business accounting methods, accrual accounting and cash accounting, lies ... Read Full Answer >>
  13. When are expenses and revenues counted in accrual accounting?

    Under the accrual basis of accounting, revenues and expenses are counted when they are earned. This is different from the ... Read Full Answer >>
  14. What is the difference between accrual accounting and accounts payable?

    Accrual accounting is one of the two primary accounting methods for businesses, cash basis accounting being the other. Accounts ... Read Full Answer >>
  15. How is revenue related to retained earnings?

    For accountants and investors alike, revenue and retained earnings represent important figures reported by corporations. ... Read Full Answer >>
  16. When are businesses required to use accrual accounting?

    Accrual accounting involves stating revenues and expenses as they occur, not necessarily when cash is received or paid out. ... Read Full Answer >>
  17. How does accrual accounting differ from cash basis accounting?

    The main difference between accrual and cash basis accounting is the timing of when revenue and expenses are recognized. ... Read Full Answer >>
  18. Given a good bookkeeping system, would financial accounting be necessary?

    Bookkeeping and financial accounting may seem like they are new creations, but variations have been around for millennia. ... Read Full Answer >>
  19. What is the difference between amortization and depreciation?

    Because very few assets last forever, one of the main principles of accrual accounting requires that an asset's cost be proportionally ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    Measuring Company Efficiency

    Three useful indicators for measuring a retail company's efficiency are its inventory turnaround times, its receivables and its collection period.
  2. Taxes

    Get A Tax Credit For Your Foreign Investments

    The foreign tax credit provides a break on investment income made and taxed in a foreign country.
  3. Markets

    Operating Cash Flow: Better Than Net Income?

    Differences between accrual accounting and cash flows show why net income is easier to manipulate.
  4. Markets

    Cash Flow On Steroids: Why Companies Cheat

    Pressure to be the best can sometimes push corporations to cheat. Learn how they do it and how to spot it.
  5. Retirement

    Navigating Government And Nonprofit Financial Statements

    Learn how to trace where your tax dollars and charitable donations are going.
  6. Options & Futures

    Advanced Financial Statement Analysis

    Learn what it means to do your homework on a company's performance and reporting practices before investing.
  7. Economics

    Understanding the Top Line

    Top line refers to a company’s gross sales without any reductions for discounts or returns.
  8. Economics

    What's an Allowance for Doubtful Accounts?

    The allowance for doubtful accounts represents the percentage of the accounts receivable the company expects to write-off as uncollectible.
  9. Fundamental Analysis

    Understanding Activity Ratios

    Activity ratios measure how effectively a business uses its assets.
  10. Investing Basics

    What is Accrued Income?

    In a mutual fund, accrued income is earnings that have accumulated over the year, but have not yet been paid out to shareholders.

You May Also Like

Hot Definitions
  1. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  2. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
  3. Nuncupative Will

    A verbal will that must have two witnesses and can only deal with the distribution of personal property. A nuncupative will ...
  4. OsMA

    An abbreviation for Oscillator - Moving Average. OsMA is used in technical analysis to represent the variance between an ...
  5. Investopedia

    One of the best-known sources of financial information on the internet. Investopedia is a resource for investors, consumers ...
  6. Unfair Claims Practice

    The improper avoidance of a claim by an insurer or an attempt to reduce the size of the claim. By engaging in unfair claims ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!