Accrual Concept in Accounting

Accrual Concept in Accounting

Accrual Concept or accrual basis of accounting is the method of accounting which involves recording the accounting entries in the books of accounts when the revenues & expenses becomes accrue /due and not when the money against such revenues & expenses are received & paid respectively.

Explanation with Example:

Accrual basis of accounting is the accounting method is also known as the mercantile method of accounting and this method require the revenues to be recorded at the time it is earned regardless of the cash receipt against it and the expenses are recognized at the time when they are incurred regardless of the actual cash payment. Thus, under the accrual system of accounting the deferrals, depreciation, allocations and amortizations are considered.

Most of the organizations follow accrual system of accounting as they reflect more accurate results of the business. Accrual accounting ensures that the reporting of revenues, costs, assets and liabilities are made in the correct accounting period.

The example of Accrual basis of accounting is explained below:

Suppose there is a company named Multifunctional Inc. which deals with the mobile, laptops and related accessories. Following transactions happened in the accounting year 2019-20.

ParticularsAmount ($)
Credit Sales25,000
Cash Sales7,000
Credit Purchases10,000
Cash purchases5,000
Salary due at the end of accounting year1,000
Salary paid in cash4,000
Expenses paid for next accounting year1,000
Advance paid to supplier for purchase in next accounting year.2,000

We need to analyze what transactions are recorded in financial year 2019-20.

Solution:

Calculation of Profit as per Accrual basis of accounting:

ParticularsAmount ($)
Credit Sales25,000
Add: Cash Sales7,000
Add: Interest accrued2,000
TOTAL INCOME [A]34,000
  
Credit Purchases10,000
Add: Cash purchases5,000
Add: Salary due at the end of accounting year1,000
Add: Salary paid in cash4,000
TOTAL EXPENSES20,000
  
NET PROFIT [A-B]14,000

Since the expenses paid for next accounting year and the advance received against purchase is not incurred in the given accounting year. Therefore, they both are not taken into consideration while calculating net profit as per the accrual basis of accounting

Advantages of Accrual Concept:

Advantages of Accrual basis of accounting are as under:

1.      More Accurate

Accrual basis of accounting provides more accurate & fair picture of the overall financial performance of the business as the revenues, expenses, assets & liabilities are taken in to consideration when they are accrued.

2.      Preferred by users of financial statements:

The business organizations that follow accrual basis of accounting are looked as more permanent and established organizations as compared to the ones that follow cash basis of accounting as cash basis of accounting only works in small businesses.

3.      Less chances of error:

When the Accrual basis of accounting is followed the chances of error is less as the transaction is recorded as and when it occurs and accrual basis is based on the double entry system of accounting. Therefore, by checking the total of debuts with the credits errors can be easily traced and minimized.

Disadvantages of Accrual Concept:

Disadvantages of Accrual basis of accounting are as under:

1.      Complex:

 The accrual basis of accounting is somewhat complex as compared to the cash basis of accounting because it requires every transaction to be incorporated in the books of accounts as & when it occurs.

2.      Requires professionals:

The recording of transactions as per accrual basis of accounting many time requires professionals and Hiring of professionals increases the salary cost of the organization.

3.      More taxes: The organizations have to pay taxes on the revenues even if the same is not received by them in actual cash

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11 thoughts on “Accrual Concept in Accounting

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