Accrual Accounting

Loading the player...

What is 'Accrual Accounting'

Accrual accounting is 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.

BREAKING DOWN '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.

RELATED TERMS
  1. Modified Cash Basis

    An accounting method that combines elements of the two major ...
  2. Cash Basis

    A major accounting method that recognizes revenues and expenses ...
  3. Cash Cost

    A cash basis accounting cost recognition process that classifies ...
  4. Accounting Method

    The method by which income and expenses are reported for taxation ...
  5. Cash Accounting

    An accounting method where receipts are recorded during the period ...
  6. Modified Accrual Accounting

    An accounting method commonly used by government agencies that ...
Related Articles
  1. Investing

    How To Decipher Accrual Accounting

    Accrual accounting is an important method of measuring the performance and position of a company. Learn more on how its used.
  2. Markets

    Earnings Quality: Analyzing Specific Accrual Accounts

    By Tim Keefe,CFA (Contact Author | Biography)Not all accrual accounts are subject to the same management manipulation, and some accruals are worth more attention than others. Recall Figure 6 ...
  3. Markets

    Earnings Quality: Defining "Good Quality"

    By Tim Keefe,CFA (Contact Author | Biography)In order to understand a company's financial report, you need to understand the accounting concepts that are used to justify the accounting rules. ...
  4. Markets

    Earnings Quality: Measuring Accruals

    By Tim Keefe,CFA (Contact Author | Biography)As was noted earlier, earnings management is predominantly a function of manipulating accruals, so it is intuitive to use the magnitude of accruals ...
  5. Professionals

    What is Cash Basis Accounting?

    Cash basis accounting recognizes revenues and expenses at the time cash is paid or received.
  6. Professionals

    Accounting Methods

    Accounting Methods
  7. Investing

    What does Accrual Mean?

    In accrual-based accounting, transactions are recorded on the books as they occur, even if payment has not yet been received or made. Accruals represent liabilities and non-cash-based assets. ...
  8. Markets

    Earnings Quality: Why Aren't All Earnings Equal?

    By Tim Keefe,CFA (Contact Author | Biography)One company's reported earnings are not of the same exact quality as another's because each management team uses its own judgment when recording business ...
  9. Professionals

    Introduction

    CFA Level 1 - Section 6: Financial Statements. Introduction to financial statements. Briefly introduces the concept of financial statement analysis and two main accounting methods.
  10. Fundamental Analysis

    Cash Flow From Investing

    Cash flow analysis is a critical process for both companies and investors. Find out what you need to know about it.
RELATED FAQS
  1. When are expenses and revenues counted in accrual accounting?

    Take an in-depth look at the treatment of revenues and expenses within the accrual method of accounting and learn why many ... Read Answer >>
  2. What is the difference between accrual accounting and cash accounting?

    Understand the differences between the two basic methods of accounting commonly used by businesses: cash accounting and accrual ... Read Answer >>
  3. When is revenue recognized under accrual accounting?

    Discover how to report revenue under the accrual method of accounting and why a firm recognizes revenue even when cash has ... Read Answer >>
  4. What is accrual accounting used for in finance?

    Read about the accrual method of accounting, its uses and rules, and why it is considered so important for investors, lenders ... Read Answer >>
  5. When are businesses required to use accrual accounting?

    Determine when the accrual accounting method must be used instead of cash accounting. Most businesses use accrual accounting ... Read Answer >>
  6. 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 Answer >>
Hot Definitions
  1. Law Of Demand

    A microeconomic law that states that, all other factors being equal, as the price of a good or service increases, consumer ...
  2. Cost Of Debt

    The effective rate that a company pays on its current debt. This can be measured in either before- or after-tax returns; ...
  3. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  4. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  5. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  6. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
Trading Center