Accrual accounting

Definition

Accrual accounting recognizes revenues and expenses when they are incurred, regardless of when cash transactions occur. This method provides a more accurate picture of a company's financial position by matching income to the time period in which it is earned.

5 Must Know Facts For Your Next Test

1. Accrual accounting follows the revenue recognition and matching principles.
2. Adjusting entries are necessary to update account balances before preparing financial statements under accrual accounting.
3. Common adjusting entries include accrued revenues, accrued expenses, deferred revenues, and prepaid expenses.
4. Accrual accounting is required by Generally Accepted Accounting Principles (GAAP) for most businesses.
5. Failure to make adjusting entries can result in misstated financial statements.

Review Questions

• Why are adjusting entries necessary in accrual accounting?
• What principles does accrual accounting follow to recognize revenues and expenses?
• Name two types of common adjusting entries.

Related terms

Revenue Recognition Principle:

This principle dictates that revenue should be recognized when it is earned, regardless of when cash is received.

Matching Principle:

This principle requires that expenses be matched with the revenues they help to generate within the same period.

Deferred Revenue:

Money received for goods or services which have not yet been delivered or performed and therefore cannot be recorded as revenue yet.