The accrual concept is an accounting method used to record revenue and expenses when they occur rather than when they are paid.
This means that revenues and expenses are recognised on the income statement in the period they are generated or incurred, regardless of when the cash is received or paid. This is the case regardless of when the cash is received or paid.
Accounting standards mandate that it must be taken into account and recorded in the statements of financial position. Recording an item on an accrual basis provides accurate and reliable financial information. Some income items may be double-counted or undercounted if a cash basis is adopted.
The concept of accrual is one of the most significant concepts in financial accounting as well as in a great many other accounting systems. It is also the foundation of the various systems used to report financial information. The ‘Accrual Concept’ has been approved by the International Accounting Standards Board (IASB). It is the standard concept of accounting for the transaction date used for a company’s financial reporting purposes. It applies to transactions or events other than the sale or purchase of merchandise.
How Are the Transactions Recorded in the Accrual System?
As per this concept, the effect of transactions and other events is recognised when they occur and not when cash or cash equivalent is received or paid. They are recorded in the transaction records and reported in the financial statements of the period in which they occur.
A financial statement is prepared on an accrual basis to inform the users about past events involving payment and receipt in cash, obligations to pay some money in the future, and resources that represent cash to be received in the future.
For example, a firm sells goods for $55000 on 15th March 2021 and the payment is not received until 15th April 2021; the amount is due and payable to the firm on the date of sale, i.e. 15th March 2021. It must be included in the revenue for the year ending 31st March 2021.
Similarly, expenses are recognised when services are provided, irrespective of the money received for these services.
For example, if the firm received goods costing $20000 on March 26th, 2021, but the payment was made on April 12th, 2021, the accrual concept requires that expenses must be recorded for the year ending March 31st, March 2021. Although no payment has been made until March 31st, 2021, the service has been received, and the person to whom the payment should have been made is shown as a creditor.
Importance of Accrual Concept in the Financial Accounting
The accrual concept gives more accuracy to financial reporting. The accuracy is given by adjusting financial statements with revenue and expenses which will be disclosed within a certain period of time. For example, in the annual financial statement, if a firm purchases some new asset, it will adjust its financial statement with the new acquisition, giving more accuracy.
With the help of the accrual concept, firms can prepare a proper balance sheet. The balance sheet will represent not only the firm’s cash position but also its assets and liabilities. The accrual concept is a system where the firm cannot recognize revenue and expenses in the current year. It requires a specific period for them to be recognized.
The accrual concept is one of the most fundamental concepts in financial accounting. Under this concept, revenue is recognised when earned, and expenses are recognised when they are incurred, regardless of when the cash changes hands. This principle is based on the idea that financial statements should accurately reflect a company’s financial position and performance over time.