/ Encyclopedia

Accrual Accounting

Definition:

Accounting method that records revenues and expenses when they are incurred, regardless of when cash is exchanged. The term "accrual" refers to any individual entry recording revenue or expense in the absence of a cash transaction

Most businesses typically use one of two basic accounting methods in their bookkeeping systems: cash basis or accrual basis. While most businesses use the accrual basis, the most appropriate method for your company depends on your sales volume, whether or not you sell on credit, and your business structure.

The cash method is the simplest in that the books are kept based on the actual flow of cash in and out of the business. Income is recorded when it’s received, and expenses are reported when they’re actually paid. The cash method is used by many sole proprietors and businesses with no inventory. From a tax standpoint, it is sometimes advantageous for a new business to use the cash method of accounting. That way, recording income can be put off until the next tax year, while expenses are counted right away.

With the accrual method, income and expenses are recorded as they occur, regardless of whether or not cash has actually changed hands. An excellent example is a sale on credit. The sales are entered into the books when the invoice is generated rather than when the cash is collected. Likewise, an expense occurs when materials are ordered or when a workday has been logged in by an employee, not when the check is actually written. The downside of this method is that you pay income taxes on revenue before you’ve actually received it.

Should you use the cash or accrual method in your business? The accrual method is required if your business’s annual sales exceed $55 million and your venture is structured as a corporation; additionally, businesses with inventory must also use the accrual method. It’s also highly recommended for any business that sells on credit, as it more accurately matches income and expenses during a given time period.

The cash method may be appropriate for a small,cash-based business or a small service company. You should consult your accountant when deciding on an accounting method.

Related Content

Product Development

The overall process of strategy, organization, concept generation, product and marketing plan creation and evaluation, and commercialization of a new product

Exit Interview

The formal conversation that takes place between an employee and an HR or other manager to determine the reason(s) the employee is leaving

Primary Market Research

Iinformation that comes directly from the source--that is, potential customers. You can compile this information yourself or hire someone else to gather it for you via surveys, focus groups and other methods.

Credit Policy

Guidelines that spell out how to decide which customers are sold on open account, the exact payment terms, the limits set on outstanding balances and how to deal with delinquent accounts

Mergers

The combination of one or more corporations, LLCs, or other business entities into a single business entity; the joining of two or more companies to achieve greater efficiencies of scale and productivity

Subchapter S Corporation

A special form of corporation that allows the protection of limited liability but direct flow-through of profits and losses