Accrual accounting is one of the most accepted accounting methods. In this method, recognition of revenue is made after conduction of sale regardless of cash or credit sale and the recognition of expense is made at the time it is incurred regardless of the time of payment. Moreover, majority of the business owners use accrual accounting method. In accordance with accrual accounting, the accountant is involved in recording revenue or expense at the time of occurrence. There is no relationship with cash inflow or timing of cash inflow.
This method is based on an accounting principle, which is identified as matching principle. Matching principle requires the expense to be recorded in line with revenue. There are certain features of accrual-based accounting system that could be summarised as follows:
There is recognition of revenue at the time it is earned regardless of whether cash is received or not.
There is matching of expenses against revenues made in realisation thereto like consumption of raw materials is matched against the products sold.
Expenses that could be detected clearly with the accounting year are treated in the form of expenses in the year although there might be no direct association with revenue of that year. These costs are adjudged as period costs and they are expensed in the pertinent period like rent, salary and others.
The expenses not charged to income are brought forward and they are kept under constant review along with any other expense that seems to have lost such as deferred revenue expenditure.
Accrual accounting system provides a number of benefits that could be discussed as follows:
Holistic approach: Accrual accounting is a system of holistic accounting, which is not like cash accounting system. There is no denying the fact that a business does not deal only in cash. In fact, certain other aspects have to be taken into consideration. In this system, it is possible to record all the financial transactions of a business like cash and others and financial statements could be created like the income statement and balance sheet statement for obtaining a holistic view of the performance of the organisation.
Absence of discrepancies: With the immediate record of financial information with its occurrence, there are minimised chances of errors or discrepancies. Moreover, since important data are recorded timely, if any person wants to conduct an audit, there is immediate availability of information.
Increased level of accuracy: Accrual accounting is involved in following double entry system unlike cash accounting system. This implies debiting one account and crediting the other account. As a result, it is possible to observe the way through which one account is minimised and another account is increased. This raise the level of accuracy of accounting and later on during audit, things would become easier.
However, accrual accounting is subject to a number of limitations and they are enumerated briefly as follows:
Complexity: It is easy to record and maintain cash accounting in contrast to the accrual accounting system. On the other hand, accrual accounting is quite difficult to record, as each time there is occurrence of a financial transaction; an entry needs to be made in the books of accounts of the concerned organisation.
Issues in maintenance: There are many different aspects of a business organisation. In case; if an organisation has large-scale operations, in a single day, there would be record of huge number of business transactions. Maintaining all these transactions on daily basis is never an easy job for an accountant.
For instance, it is assumed that ABC Limited has sales revenue amounting to $10,00,000. From the total sales revenue, 60% of sales are made in cash. The issue here is to conduct the treatment under accrual accounting basis. In accordance with the accrual accounting system, 40% of sales are made in credit terms. However, the credit sales would be treated in the form of sales and there would be generation of profit by incorporating both cash and credit sales, after which there would be deduction of cost of sales and operating expenses. In case of cash accounting, there would be no record of credit sales. The following example shows the instance of accrual accounting system extracted from the statement of financial position of Colgate. It could be seen that Colgate has disclosed accounts receivable of $1,411 million and $1,427 million in 2016 and 2015 respectively.
Therefore, accrual accounting system considers all sales and expenses whether they are earned or paid at any point of time.
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