What is accrual-basis accounting?

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.

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 when they are earned and costs to the period they were used. A sale still sits in the earned month, 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 shop delivers the goods or services. Card batches, checks, and cash in the till are collections, not the earning event.

How accrual-basis books date activity:

• Record revenue when it is earned, even if cash has not landed
• Record expenses when they are incurred, even if the vendor is paid later
• Use period-end adjusting entries for earned-but-uncollected and used-but-unpaid slices
• Use deferrals when cash already moved and recognition still waits
• Read cash from operations for the till; do not treat net income as money in the register

Expenses are recorded when the shop uses the cost. Supplies used this month are this month's cost even if the vendor is paid next month.

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.