About Accrual Basis Accounting

Accrual basis accounting is the process of relating the financial effects of transactions, events, and circumstances having cash consequences to the period in which they occur rather than when the cash receipt or payment occurs.

Accrual accounting:

• Encompasses the matching principle, which states that the total expenses involved in obtaining the revenues of the period must be computed and related to the revenues recorded for that period before the income of a company may be determined.
• Is the primary accounting method under Generally Accepted Accounting Principles (GAAP).
• Attempts to reflect an accurate measurement of a company's financial position, results of operations and cash flows.
• Attempts to prohibit income manipulation.

Revenue under accrual basis accounting is recorded and reported when: (1) realization has taken place, and (2) the earning process is complete or nearly complete.

• Realization is the process of converting non-cash resources into cash or rights to cash.
• Earning process is the acquisition, production and/or distribution, sales, and collection of cash. Earning process is complete or nearly complete when the company has accomplished what it must do to be entitled to the benefits.

Expenses under accrual basis accounting have the following criteria:

• Matching: Allocation of expenses incurred (efforts) against revenues (benefits) earned during the period.
• Association of Cause and Effect: Costs recognized as expenses based on direct association with revenues.
• Systematic and Rational Allocation: Costs recognized as expenses based on systematic and rational allocation (e.g., depreciation and amortization).
• Immediate Recognition: Costs recognized as expenses in the current period because either there are no discernible future benefits or it is not useful to allocate those costs to future periods.