accrual concept in accounting

What is the accrual concept in accounting

ACCOUNTING

Accrual concept in Accounting-By this post, we shall study in detail the important Accrual concept out of 12 various accounting concepts on which accounting is based. If you have a business then you should know about these important Accrual concepts.

What is the meaning of accrual concept?

According to the accrual concept, the effects of transactions and other events are recognized on a mercantile basis means, when they occur (and not as cash or a cash equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statements of the periods to which they relate.

How can you explain the Accrual concept with an example?

To understand the accrual concept, you should have knowledge of revenues and expenses. Revenue is the gross inflow of cash, receivables, and other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from rendering services, and from the use by others of the enterprise’s resources yielding interest, royalties, and dividends.
For example,

Example (1) Mr. Shyam started cloth merchandising. He invested 20,000₹, bought merchandise worth 20,000₹. He sold such merchandise for 40,000₹. Customers paid him 30,000₹ cash and assure him to pay 10,000₹ shortly. His revenue is 40,000₹. It arose in the ordinary course of cloth business; Mr. Shyam received 30,000₹ in cash and 10,000₹ by way of receivables.

Example (2) An electricity supply undertaking supplies electricity spending 8,00,000₹ for fuel and wages and collects electricity bill in one month 10,00,000₹ by way of electricity charges. This is also revenue that arose from rendering services.

Example (3) Mr. Mayur invested 1,00,000₹ in a business. He purchased a machine paying 1,00,000₹. He rented it for 20,000₹ annually to Mr.Ram. 20,000₹ is the revenue of Mr. Mayur; it arose from the use.

Expense is a cost relating to the operations of an accounting period or to the revenue earned during the period or the benefits of which do not extend beyond that period.

In the first example, Mr. Shyam spent 20,000₹ to buy the merchandise; it is the expense of generating a revenue of 40,000₹. In the second instance, 8,00,000₹ are the expenses. Also whenever any asset is used it has a finite life to generate benefit.

Suppose, the machine purchased by Mr. Mayur in the third example will last for 10 years only. Then 10,000₹ is the expense every year relating to the cost of machinery.

What is the meaning of accrual for accrual concepts?

Accrual means recognition of revenue and costs as they are earned or incurred and not as money is received or paid. The accrual concept relates to the measurement of income, identifying assets and liabilities.

For Example, Mr. Jon buys clothing of 50,000₹ by paying cash of 20,000₹ and sells at 60,000₹ of which customers paid only 50,000₹.
Here His revenue is 60,000₹, not 50,000₹ cash received.
Expense (means the cost incurred for the revenue) is 50,000₹, not 20,000₹ in cash paid.
So the accrual concept-based profit is 10,000₹ (Revenue – Expenses).
As per Accrual Concept: Revenue – Expenses = Profit
The accrual concept provides the foundation on which the structure of present-day accounting has been developed.
Alternative as per Cash basis,
Cash received in the ordinary course of business – Cash paid in the ordinary course of business = profit.
Timing of revenue and expense booking could be different from cash receipt or paid.

How does the accrual concept work?

S.NoTransactionAccrual concept Effects
1When cash is received before revenue is bookedA liability is created when cash is received in advance
2When cash is received after revenue is  bookedAn asset called Trade receivables is created
3And When cash is paid before the expense is bookedCreates an asset called Trade Advance when cash is paid in advance
4When cash is paid after the expense is booked Creates a liability called payables or Trade payables or outstanding liabilities

What are the advantages and disadvantages of the accrual concept?

These are the advantages and disadvantages of the accrual concept-

AdvantagesDisadvantages
The accrual basis of accounting tends to provide more even recognition of revenues and expenses over time, and so is considered by investors to be the most valid accounting system for ascertaining the results of operations, financial position, and cash flows of a business. In particular, it supports the matching principle, under which revenues and all related expenses are to be recorded within the same reporting period; by doing so, it should be possible to see the full extent of the profits and losses associated with specific business transactions within a single reporting period.A significant failing of the accrual basis of accounting is that it can indicate the presence of profits, even though the associated cash inflows have not yet occurred. The result can be a supposedly profitable entity that is starved for cash, and which may therefore go bankrupt despite its reported level of profitability. Consequently, you should pay attention to the statement of cash flows of a business, which indicates the flows of cash into and out of a business.

Can you avoid the accrual concept in accounting?

Yes, A small business may choose to avoid using the accrual basis of accounting, since it requires a certain amount of accounting expertise. Also, a small business owner may choose to manipulate the timing of cash inflows and outflows to create a smaller amount of taxable income under the cash basis of accounting, which can result in the deferral of income tax payments.

Further Faqs related to accrual concepts

  1. Why is the accrual concept needed?

    The Accrual concept is required due to complexity in business transactions and measurement of the performance of a business in a particular period.

  2. What is the impact of Accounting on the bases of the accrual concept?

    In addition to accruals adding another layer of accounting information to existing information, they change the way accountants do their recording. In fact, accruals help in demystifying accounting ambiguity relating to revenues and liabilities. As a result, businesses can often better anticipate revenues while keeping future liabilities in check.

  3. Where is the Accrual concept Useful?

    Accrual accounting on the basis of the accrual concept is popularly used by businesses where a lot of credit transactions take place. When goods and services are sold on credit on a daily basis, it becomes tough for the business to keep track of the goods and services sold and the credit issued if the transaction does not end with the payment of cash at the time.

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