Understanding Accrual Accounting
Accrual accounting is a method of recording transactions, including both revenue and expenses, when they occur, regardless of the timing of cash receipts or payments.
In this approach, revenue is recognized when goods or services are delivered, even if the customer has not paid yet.
It assumes that the customer will pay shortly and treats the amount as an asset until it is received.
Similarly, expenses are recorded when goods or services are consumed, not when payment is made.
This practice follows the accruals concept, ensuring that transactions are accounted for in the period they occur, providing an accurate and fair representation of the business’s financial position.
Understanding Accrued Revenue
Accrued revenue is recorded when a customer purchases but defers the payment later.
On the date when the goods or services are provided, the accountant debits the receivables account, representing the amount owed by the customer.
At the same time, the sales account is credited.
When the payment is eventually received, the accountant debits the cash/bank account and credits the sales receivables account, reflecting the completion of the transaction.
Understanding Accrued Expenses
An accrued expense arises when a business purchases raw materials on credit to produce its goods.
This means that the business receives the raw materials before making the payment.
On the day the raw materials are received, the business credits the trade payables account, representing the amount owed to the supplier, and debits the purchases account to record the increase in inventory.
When the payment is made, the trade payables account is debited to reduce the balance, and the bank/cash account is credited, reflecting the settlement of the accrued expense.