Accrual basis accounting

Definition

Accrual basis accounting records revenues and expenses when they are earned or incurred, regardless of when cash is actually exchanged. This method provides a more accurate picture of a company's financial position than cash basis accounting.

5 Must Know Facts For Your Next Test

1. Accrual basis accounting recognizes revenues when they are earned and expenses when they are incurred.
2. It is required by Generally Accepted Accounting Principles (GAAP) for publicly traded companies.
3. Accrual accounting provides a better matching of revenues and expenses in the same period.
4. Adjusting entries are often necessary to ensure that all income and expense items are recorded in the correct period.
5. The use of accrual basis can impact the figures shown on the income statement, balance sheet, and statement of cash flows.

Review Questions

• What is the main difference between accrual basis accounting and cash basis accounting?
• Why does GAAP require the use of accrual basis accounting?
• How do adjusting entries play a role in accrual basis accounting?

Related terms

Cash Basis Accounting:

Recognizes revenues and expenses only when cash changes hands.

Matching Principle:

Requires that expenses be matched with the revenues they help to generate during the same period.

Adjusting Entries:

Journal entries made at the end of an accounting period to allocate income and expenditures to the correct periods.