What Is Accrual Accounting: How Does It Work and Why You Should Use It

What Is Accrual Accounting: How Does It Work and Why You Should Use It

Accrual accounting is one of the aspects of running a successful business. It’s a method of recording and tracking financial transactions occurring throughout a business’s activity. Accrual accounting is more complex than cash-based accounting and requires a greater understanding of business operations, but it also provides more accurate insights into the company’s financial health.

Read on to learn more about accrual accounting, how it works and why it is essential to the success of your business.

What is accrual accounting?

By definition, accrual accounting is one of the accounting methods businesses can choose from to do their books. The accrual accounting system allows companies to record their revenues and expenses as soon as they occur, notwithstanding whether the actual money was received or paid. 

Okay, it might seem a little complicated, so let’s explain with an example. Imagine your business sold some goods this month, expecting to receive the payment next month. So, using the accrual method, you’ll record the expected revenue in the books as accounts receivable. The same thing works for your due payments. As soon as you receive some service or buy some goods, you record it in the books — even though you haven’t yet paid for it.

Companies that use the accrual accounting method that implies recording account receivables and payables can usually have a more accurate picture of their profitability in the long term.

How does accrual accounting work?

Now, let’s drill a little deeper into how accrual accounting works. 

As previously mentioned, accruals are revenue and expenses a business expects to earn or pay in the future rather than actual cash ins and outs (which is the main difference between accrual and cash-based accounting). At this point, accrual accounting allows businesses to have more informative financial statements, reflecting – besides the cash received – revenue expected from other business activities or a company’s future liabilities.

Usually, double-entry bookkeeping is implied when working with accruals. Here’s how it works.

For payments expected but not yet received, a company creates a journal entry for an accrual revenue that includes both debiting the “accounts receivable” account and crediting the “revenue” account on the income statement.

For the incurred expenses (to be paid in the future), an accrual expense journal entry is created, involving debiting the “expenses” account on the income statement and crediting the “accounts payable” account.

Benefits of accrual accounting

Compared to cash-based accounting, accrual accounting has some definitive advantages.

Accurate financial records

Accurate cash flow tracking increases accuracy in financial reporting. It allows for better business decision-making, enabling you to make more informed choices about expenses, investments, and other financial decisions. 

Balanced books

Accurate financial records mean that your books are balanced: there are no unrecorded expenses or revenues, and the figures match. It’s essential for auditing and ensures that the books are easy to understand and manage. 

Long-term financial planning

Accurate accounting records allow you to make better long-term financial decisions, such as assessing the financial viability of new projects, managing cash flow, determining a company’s creditworthiness, and making strategic investments.

How to set up and successfully manage an accrual accounting system

Setting up and managing an accrual accounting system might require some preparation and best practices you might want to follow. Let’s look at what those might include.

  • Review your current accounting system

Before setting up an accrual accounting system, you need to review your current system and understand your current accounting practices. It includes understanding the terminology, the system in place, and recorded data. 

  • Review your organizational structure

Similarly, you need to understand your company’s organizational structure, including departments, functions, and other factors that impact the accounting process. This information will help you identify where changes or additions might be necessary for the accounting process. 

  • Assess your accounting requirements

When setting up an accrual accounting system, it is crucial to identify your business requirements. It might include understanding the purpose of your company and the financial goals you are trying to achieve. You might also want to identify the data you need to track and the parties involved in the accounting process.

  • Define roles and responsibilities

You’ll need to define roles and responsibilities for the individuals involved in the accounting process, including executives and managers, accountants, and other staff members that may be involved in the process. This way, you ensure that accounting activities are transparent and that responsibilities are clear.

  • Implement controls and checks

You might want to introduce control and check procedures within your accounting process to ensure the accuracy of recorded data and prevent fraud. They might involve regular audits or other means of checking and confirming accounting accuracy.

  • Keep your accounting data up to date

Finally, it is important to keep your accounting data up to date. The good rule of thumb here may be recording new transactions as soon as they occur and updating your books regularly. Regular reconciliation of the books might also be of help. At this point, you might consider using accounting automation software as the best means of keeping your records accurate and reconciling without flaws and discrepancies.

Accrual accounting: final words

Accrual accounting is one of the accounting systems a business can choose to manage its financial records. In contrast with cash-based accounting, accrual accounting requires recording income or expenses as soon as they occur, though they can be unpaid. So it’s more about recording expected income and expenses and balancing them (debiting and crediting) in the right accounts. Accrual accounting is considered a better choice for a business because it allows for more accuracy of the books and a better overview of a company’s profitability.

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Volha Belakurskaja

Volha Belakurskaja

Volha is an experienced copywriter with 10+ years experience writing for the information technology and services industry and a 5+ years sole proprietorship background. Passionate about all things tech, she is especially interested in topics lying at the confluence of business and technology.

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