accrual accounting


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Accrual Accounting

A system of accounting that recognizes revenue and matches it with the expenses that generated that revenue. Unlike other systems of accounting, which recognize revenue and expenses in the order in which they are received, the accrual accounting convention ignores the function of time and only considers what expenses generate what revenues, even if payments have not actually been made. Companies with inventories are required to use the accrual method for tax purposes.

accrual accounting

A method of accounting that recognizes expenses when incurred and revenue when earned rather than when payment is made or received. Thus, it is the act of sending the goods or receiving an inventory item that is important in determining when transactions are posted on financial statements. For example, using accrual accounting, sales are recorded as revenue when goods are shipped even though payment is not expected for days, weeks, or months. Most firms use the accrual basis of accounting in recording transactions. Compare cash basis accounting.
Case Study Recording revenues that are used to calculate earnings before actually receiving those revenues can potentially misrepresent a firm's financial results and lead to financial difficulties down the road. For example, a company that ships substantial amounts of goods on credit may produce outstanding earnings in the current accounting period, but if customers who receive the goods fail to pay for the merchandise, future earnings are likely to suffer. Firms build an estimate for doubtful payments into the revenues and earnings they report, but the estimates may be understated and make earnings look better than they actually are. More than a few companies have been known to ship unusually large amounts of merchandise near the end of a fiscal year in order to make the year's sales and earnings appear favorable even though the extra sales produce an unrealistic picture of the firm's operations. In one instance, a large toy company was offering special incentives to customers that loaded up with the firm's merchandise just prior to the end of the year. This, of course, is perfectly legal. However, the company offering the incentives was accused of overstating its earnings by not properly accounting for the expense of the incentives being offered. A firm that aggressively pursues end-of-year sales may end up selling to some financially weak customers who fail to pay for the merchandise. Unfortunately, it is difficult for stockholders to know the extent to which a firm's actions serve to puff up the financial statements rather than produce real results.
References in periodicals archive ?
By now, we all should understand the reasons for implementing the new accrual accounting within federal agencies.
Accrual accounting also allows a clearer picture of restricted funds, such as those marked for a particular purpose.
The requirement to maintain inventories is one of the triggers for accrual accounting.
By that time, accrual accounting concepts were entrenched.
This paper provides evidence on the usefulness of cash flow data in the prediction of business failure and whether the integration of cash flow data with accrual accounting data can provide a superior measure over accrual accounting data alone for predicting bankruptcy.
The federal government agreed to the bailout only if New York switched to accrual accounting.
We have succeeded in implementing a 'dual system' based on accrual accounting principles for general accounting and on cash accounting for running the budget.
These proposals do not apply to certain businesses that the tax law requires to use accrual accounting.
Overall, tax reform must be regarded as having had a salutary effect on a nascent profession, and it had a dramatic impact on acceptance of accrual accounting by business.
3594) that restores the installment method to accrual accounting users.
It moves the budget process closer to accrual accounting, the private-sector norm, and--I would hope--the ultimate objective of federal budget accounting.
Obviously, you want to buy a program that is able to provide the fundamentals of financial management, whether it's tax preparation or accrual accounting.