Under the accrual basis of accounting expenses & revenue are recorded and are recognized when they are earned and incurred, regardless of when the cash is exchanged. It differs from cash accounting, which recognizes revenues and expenses when the cash is exchanged.
An accrual journal entry is a type of accounting entry made to record revenues or expenses that have been earned or incurred, respectively, but have not yet been received or paid. Accrual accounting is based on the accrual principle, which recognizes economic events when they are incurred, regardless of when the cash is actually received or paid.
Accrual Journal Entry Example
Suppose a company provides consulting services to a client in December but doesn't receive payment until January of the following year. According to the accrual accounting method, the company should recognize the revenue in December when the service is provided, not when the payment is received.
The two main methods of accounting are the cash basis and the accrual basis. The cash basis measures income when cash is received and expenses when cash is paid out. The accrual basis measures income when income is earned and expenses when they are incurred, regardless of when the cash changes hands.
Accrual accounting enables companies to match revenues and expenses in the same period. The main reason we use accrual accounting is to provide a more accurate financial picture of a business’s operations by aligning revenue with expenses in the same period, which creates a better understanding of future cash flows. This allows businesses to make well-informed decisions about their operations and budgeting.