There are two bases of accounting, which are cash and accrual basis. Using cash basis, when cash is accepted or paid, expenditures and revenues are recorded.
Whereas using accrual basis or the matching principle (Also see Relationship Between Matching Principle & Accounting Period), revenues are recognised on the Profit and Loss when the service is performed or in case of goods, risk and reward is transferred. Then, expenses are recognised so that the entries in the financial statement match with the revenues and expenses.
The purpose of accrual accounting is to show economic events and not merely cash changing hands randomly.
We usually end up with different outcomes under each basis due to the timing differences in payment and delivery.
Mostly, accounting standard all over the world demands the application of accrual accounting. However, accrual accounting implements the concepts of ‘incurred’ and ‘earned’ that consists of judgement, which is different from using cash where you can visualise the transactions. Hence, accrual accounting is complicated.
Why Accrual Is Important
As an entrepreneur, your financial statement is required to be precise according to the accounting principles (Also see Monetary Unit principle). Usually, you would accrue for expenses and revenue first and account for cash then when doing the bookkeeping. As a matter of fact, accruals are so common that items such as unearned revenue, accrued expenses and accounts receivable are outcomes of accrual accounting.
It helps recognise accruals in the financial reports of other businesses so that you could decide whether you want to invest or partner with them.
Accruals bring subtle implications about the business’s situation. For instance, if the receivable balance of an account increases at a much higher rate compared to the sales, this might recommend unusual sales and future collection problems. Thus, it is inexpedient to make a hasty decision without discovering out more.
Engage an accounting firm in Johor Bahru today if you seek help in managing your accounting and financial statement. If you are instead seeking for bookkeeping service in Singapore, our partner can also assist.