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ACCRUAL BASIS

Introduction:

  • Accrual principle is one of the important principles of accounting.
  • A method of recording accounting transactions for revenue when earned and expenses when incurred even when cash has not been received or paid during the period of accrual.
  • To record revenue as soon as the related invoice is issued to the customer is an example of accrual basis accounting.
  • Only Indian Railways still relies on Cash Basis of Accounting. All other major government and private organizations rely on accrual principle.
  • The techniques, methods, requirements, determinations, and discretion allowed when using the accrual method are governed by Generally Accepted Accounting Principles (GAAP).
  • Cash accounting which recognizes transactions only when there is an exchange of cash, is the opposite of Accrual accounting.

Difference between cash method and accrual method:

For example, let’s assume company ABC must insure one of its office in the year 2000 for next 10 years. The insurance company bills company ABC RS. 60,000 every five years ( one bill in 2005 and next in 2010). We can see the difference between cash basis and accrual basis through this figure:

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Advantages of the method:

  • The use of accrual accounting is more useful in businesses where there are a lot of credit transactions or the goods and services are sold on credit, which simply means that there was no exchange of cash.
  • This method gives a more accurate picture of a company’s current financial condition as it allows the current cash inflows/outflows to be combined with future expected cash inflows/outflows.

Disadvantages of the method:

  • The only drawback of this type of accounting system is that a firm might end up paying tax on revenues even when it might have not received it (credit).
  • It is more complex, harder to implement, and harder to maintain than the cash method of accounting.
  • one of the big drawbacks of accrual accounting is that it tends to obscure the nature of the company’s actual cash position.

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