What are Accounting Accruals?
Accounting Accruals refer to um financial accounting method that allows companies to record revenues before they actually receive payment for goods or services sold, as well as record expenses as they are incurred.
This method ensures that revenues obtained and expenses incurred are recorded in the company's accounting books, regardless of when the money is actually received or paid. Accounting accruals are often contrasted with the cash method, which records revenue only when payments are actually made for goods and services.
How Accounting Accruals work
The basic principle of Accounting Accruals is that accounting records are made at the time a good or service is delivered, and not necessarily when payment is made or received. Records of obligations and payments to be made are also part of this method.
This approach allows current and future cash inflows and outflows to be consolidated to provide a more accurate view of the company's current and future financial conditions.
Accounting Accruals follow the correspondence principle, which determines that revenues and expenses must be recorded in the same accounting period.
Encouraged by International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP), Accounting Accruals have become the standard for most companies, except for smaller ones and individuals.
Qualification for Accounting Accruals
Larger companies should adopt the Accounting Accruals method if their average gross revenues exceed US$25 million in the last three years. If they do not meet this criterion, they can choose the cash or accruals method as their accounting system.
Regardless of size or revenue, Accounting Accruals are mandatory for companies that maintain inventories or make sales on credit.
Benefits of Accounting Accruals
This method provides a more accurate representation of the current state of the company's finances, although its implementation can be more complex and costly.
Accounting Accruals emerged due to the increasing complexity of commercial transactions and the need for more accurate financial information. Transactions such as credit sales and projects that generate revenue over time significantly influence the financial health of a company at the time of the transaction. Therefore, it is logical that such events are also reflected in the financial statements in the same period in which they occur.
With Accounting Accruals, companies have immediate feedback on their expectations of cash inflows and outflows, facilitating the management of current resources and future planning.
Accounting Accruals vs. Cash Accounting
Accounting accruals can be contrasted with cash accounting, which records financial transactions only with the actual exchange of money. The differences between cash and accruals methods lie in the way and time of recording transactions.
Cash accounting records transactions at the time payments are made. For example, suppose a consulting company offers a service worth $5.000 to a client on October 30th. The customer receives the invoice and makes payment on November 25th. In cash accounting, revenue of US$5.000 is only recognized at the time of payment, that is, on November 25th.
In contrast, Accounting Accruals employ the double-entry accounting method. Using the same example, when the consulting company provides the service, it would record a $5.000 debit to accounts receivable (increasing an asset) and a credit to the service revenue account (increasing revenue) for the same amount. When payment is made on November 25, the debit to accounts receivable is adjusted, and the amount is transferred as needed between accounts, always using the double entry method.
Conclusion
The choice between Accounting Accruals and cash accounting is fundamental and must be aligned to the specific needs of each company, considering the nature of its operations and regulatory requirements. While cash accounting offers simplicity and a direct representation of cash flow, Accounting Accruals provide a more complete and accurate view of a company's financial health by recognizing revenues and expenses at the time the corresponding economic events occur.
For companies seeking a financial perspective that better reflects the complex realities of their business, Accounting Accruals are often the preferred choice, despite their greater complexity and cost of implementation. On the other hand, small businesses or individuals who prioritize simplicity and have less complicated cash flows may find cash accounting a suitable solution.
FAQ
How would you explain Accounting Accruals to non-accountants?
Accounting Accruals use double-entry accounting, where transactions are recorded in two accounts simultaneously at the time the commitment is made, regardless of when payment is received or made.
What is the difference between cash accounting and accounting accruals?
While cash accounting records actual payments and receipts, Accounting Accruals record income and expenses at the time services or goods are provided, or when financial obligations are assumed.
What are the three accounting methods?
The three main accounting methods are cash accounting, accounting accruals, and a hybrid method known as modified cash accounting.
