What Is Accrual Accounting?
Why profit and cash are not the same thing, with a clear comparison.
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| Accrual basis | Cash basis | |
|---|---|---|
| Revenue recorded | When earned | When cash is received |
| Expense recorded | When incurred | When cash is paid |
| Best for | Accurate performance picture | Very small, simple businesses |
Accrual accounting in plain English
Imagine you deliver a service in December and the client pays in January. On the accrual basis the revenue belongs to December, because that is when you earned it. On the cash basis it would land in January. Accrual accounting follows the matching principle: expenses are matched to the revenue they helped earn.
Worked example
In December a business uses 400 of electricity but the bill arrives and is paid in January. Under accrual accounting the 400 is a December expense and a liability (accrued expense) at 31 December.
| Account | Debit | Credit |
|---|---|---|
| Electricity expense | 400 | |
| Accrued expenses (liability) | 400 |
- Assuming profit equals cash. A profitable business can still run out of cash.
- Forgetting year-end accruals and prepayments.
Frequently asked questions
Why is accrual accounting used?
It gives a truer picture of performance by recording income and costs in the period they relate to.
Is accrual accounting required?
Most companies must use it under standards such as IFRS and GAAP. Rules for small businesses vary by country.
What is the difference between an accrued and a prepaid expense?
An accrued expense has been incurred but not yet paid. A prepaid expense has been paid in advance for a future period.
Keep learning
This page is for general learning. Accounting rules vary by country and standard.