Accrual is an accounting method that records income or expenses when they are earned or incurred, rather than when cash is received or paid. This method is based on the accrual principle, which states that financial transactions should be recognized in the period in which they occur, regardless of when the cash is received or paid.
For Example, let's say a company provides consulting services to a client and sends an invoice for $10,000. The client will pay the invoice in 30 days. Under the accrual method, the company would recognize the $10,000 of revenue in the period in which the services were provided, not in the period when the cash is received.
The journal entry for this transaction would be:
Debit: Accounts Receivable (Asset Account) $10,000 Credit: Revenue (Income Account) $10,000
When the client pays the invoice, the following journal entry is recorded:
Debit: Bank $10,000 Credit: Accounts Receivable (Asset Account) $10,000
This journal entry records the receipt of cash and the reduction of accounts receivable.
Another Example would be if a company purchases a new equipment for $20,000 and expects to use it for the next 5 years. Under the accrual method, the company would recognize the $20,000 expense in the period in which the equipment is received, not in the period when the cash is paid.
The journal entry for this transaction would be:
Debit: Equipment (Asset Account) $20,000 Credit: Accounts Payable (Liability Account) $20,000
When the company pays the invoice, the following journal entry is recorded:
Debit: Accounts Payable (Liability Account) $20,000 Credit: Bank $20,000
This journal entry records the payment of the accounts payable liability, and the reduction of cash.
In general, Accrual accounting provides a more accurate picture of a company's financial performance and helps to match revenue and expenses to the period in which they were earned or incurred, which is useful for budgeting, forecasting and tracking performance.
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