Definition of 'Accrual Accounting'
Accrual accounting measures gains and expenses without using the date of when the actual cash payment occurred. Company purchases are identified when the actual transaction occurs, rather than when the payment is finalized.
TheStreet Explains ‘Accrual Accounting’
Typically used in most company’s accounting practices, accrual accounting is important because it tracks the immediate activity, recording the company’s current condition. Accrual accounting is the opposite of cash accounting because in that instance, only the exchange of cash is recognized.
For instance, Lucy’s Sweater Factory is selling alpaca yarn, hand-knit sweaters almost faster than the knitters can keep up. Lucy takes both cash and credit cards, but finds that most people will use their credit card when making a purchase. Lucy can consider all sweater transactions to be sales (both cash and credit cards), but won’t see the actual cash until the credit card company completes the transaction. Companies like to use the accrual accounting method because business accountants take into consideration that the credit sales will eventually be paid so they can consider all transactions equal.
Typically, sales that were made with credit are line items in the accounts receivable account, which ultimately has a positive impact on revenue. Revenues and expenses are included on an income statement for cash accounting. While cash accounting records “real time” transactions on the income statement, accrual accounting requires the business manager to revisit the accounts receivable account to resolve which accounts delivered cash and which accounts are still pending.
Although universally accepted, accrual accounting has some drawbacks. For instance, it lists profits through sales that may not have been resolved. For this reason, the accounting or business manager must vigilantly pay close attention to cash inflow and out flow, keeping a keen eye on the accounts receivables. For small businesses that have limited resources and/or a company with no accounting experience, reconsidering whether to use accrual accounting should be examined. Because of the time consuming nature of this practice, small companies may want to use cash account instead.
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