Meaning and definition of accrual accounting
Accrual accounting refers to the method of accounting which evaluates the performance and position of a company by recognizing economic activities irrespective of the occurrence of cash transactions. The main idea is that the economic activities are recognized by relating the revenues to the expenses at the time when transaction has occurred instead of when payment is received or made. Also, this method allows current cash flows (in and out) to combine with prospective cash flows thus providing a more accurate picture of the financial condition of a company.
As explained by Investopedia, for most companies, accrual accounting is considered as the standard accounting practice, with an exception of very small operations. Moreover, this accounting type is the reverse of cash accounting, which identifies transactions only on exchange of cash.
Advantages of Accrual Accounting
Accrual accounting is, undoubtedly, more accurate in terms of assessing financial position of the company as it matches income with the expenses incurred in generating the same. Accrual accounting is also helpful for the managers to evaluate performance of the company with more realistic figures. Accrual accounting is, therefore, pretty safer as a quantifying tool over cash accounting.
With increasing levels of complexity in business transactions, the need for a more accurate accounting approach led the financial managers move towards accrual accounting than cash accounting. The companies dealing in credit transactions and have projects that offer cash flows not only for the current period but also for a long term have been struggling to view their financial position. The accrual accounting is helpful in overcoming these problems through a combination of current and prospective cash flows in a single financial statement.
The advantages of accrual accounting can, therefore, be summarized in following points:
- A reflection of full scope of a company’s resources, obligations, and costs.
- Offers more focus on business output rather than input.
- Is helpful to the financial managers to utilize company resources in a more efficient way.
- Ascertains a better link of resources and results produced from these products.
- Is helpful in comparing full cost of the products and services across the industry standards.