What is accrual-basis accounting?
Recording revenue when earned and expenses when incurred. A bakery records June card sales even though the batch settles in July.
Definition
Accrual-basis accounting dates revenue to the period it is earned and expenses to the period they are incurred. On the books, the Income Statement follows the work and the sale, not the day cash moved.
A bakery that swipes cards in June still books those sales in June even if the batch settles in July. The earned month is June; the bank date is July.
This is a method for the whole set of statements. It is not one adjusting journal entry and not a single account.
Where it shows up
Balance Sheet: Related to how every statement is dated under this method.
P&L: Related to how every statement is dated under this method.
Cash flow: Related to cash still moving on its own schedule, not the recognition date.
See also: Accrual · Matching Principle · Revenue Recognition
When you look at the Balance Sheet under this method, you will see balances cash has not yet moved through. Accrued liabilities hold costs already incurred; deferred revenue holds cash collected before the work.
The Income Statement dates sales to the loaf that left the counter and costs to the period they were used. A June card sale still sits in June, even while the processor is catching up.
Cash flow from operations still follows the bank. The method does not pretend cash moved on the recognition date.
The Financial Statement Package under this method is built so the three statements talk to each other. Net income on the Income Statement is not the same number as cash from operations.
How it works
Revenue is recorded when the bakery delivers the goods. Card batches, checks, and cash in the till are collections, not the earning event.
Expenses are recorded when the bakery uses the cost. Flour baked in June is a June cost even if the vendor is paid in July.
Period end is when the books catch what cash missed. An adjusting journal entry records the earned-but-uncollected and the used-but-unpaid slices.
A deferral is the other timing tool under this method. Cash already moved, and recognition waits for the earned or used month.
Stay on the method. This page is not a walkthrough of every unpaid bill or every prepaid.
The documents behind it are invoices, receipts, and the period-end list of what was earned or used but not yet cashed. Those papers date the statements; the bank feed dates cash.
Cash still has its own statement. Readers who want the till should open cash from operations, not treat net income as money in the register.
Prepaid expenses fit the same rule from the other side. The shop paid early, so expense waits until the coverage or the goods are used.
Example
Mill Street Bakery sells $8,400 of card sales in June. The processor batch does not hit the bank until July 2.
Under this method, June still records $8,400 of sales. The uncollected slice sits as a receivable until the batch settles.
June also used $2,100 of flour that will be paid in July. That cost is June expense, not July expense.
The Income Statement for June shows the earned sales and the used costs. July's bank deposit is a collection, not a new sale.
If the bakery had waited for the July settlement to book the sales, June would look empty and July would look rich. The work happened in June.
No extra journal entry is needed on July 2 to re-book the sale. That day only clears the receivable when the batch lands.
Common mix-ups
Accrual-basis accounting is not the same as an accrual. An accrual is one timing entry; this method is the whole rule for dating revenue and expense.
Accrual-basis accounting is not the same as cash-basis accounting. Cash-basis books wait for the bank; this method dates the statements to the earning and using.
Accrual-basis accounting is not the same as cash in the till. Net income can be healthy while the batch is still settling.
Related terms
- Accrual: Recording an expense or revenue when it happens rather than when cash moves.
- Deferral: Pushing recognition of a cost or revenue to a later period than the cash movement.
- Matching Principle: Recording expenses in the same period as the revenue they helped produce.
- Cash Basis Accounting: Recording revenue and expenses only when cash actually moves.
- Revenue Recognition: The rules for deciding when earned revenue may be recorded.
- Adjusting Journal Entry: An entry made at period end to record accruals, deferrals, and corrections.
- Generally Accepted Accounting Principles: The common US rules for how financial statements are prepared.
- Accrued Liabilities: Expenses incurred but not yet billed or paid at period end.