What Is Accrual Accounting?
Accrual accounting is the standard accounting method used by most businesses, where transactions are recorded when they occur economically, not when cash changes hands. Under accrual accounting:
- Revenue is recorded when earned (goods delivered, services performed)
- Expenses are recorded when incurred (goods received, services consumed)
This matching of revenue and expenses in the same period provides a more accurate picture of profitability than tracking only cash movements.
Accrual vs. Cash Accounting
| Aspect | Accrual Accounting | Cash Accounting |
|---|---|---|
| Revenue timing | When earned | When received |
| Expense timing | When incurred | When paid |
| Complexity | Higher | Lower |
| Accuracy | More accurate | Less accurate |
| Required for | Larger companies, GAAP | Small businesses only |
| Matching | Revenue matched to expenses | No matching |
Example: Consulting Project
You complete a $10,000 consulting project in December. Client pays in January.
Cash Accounting:
- December: $0 revenue
- January: $10,000 revenue
Accrual Accounting:
- December: $10,000 revenue (when earned)
- January: $0 revenue (already recorded)
Accrual accounting shows the revenue in the period the work was performed.
Key Accrual Concepts
Accrued Revenue
Revenue earned but not yet billed or collected:
Debit: Accrued Revenue (Asset) $5,000
Credit: Service Revenue $5,000Example: Work completed in December, invoice sent in January.
Accrued Expenses
Expenses incurred but not yet paid:
Debit: Salary Expense $50,000
Credit: Accrued Salaries (Liability) $50,000Example: December salaries paid in January.
Deferred Revenue
Payment received before revenue is earned:
Debit: Cash $12,000
Credit: Deferred Revenue (Liability) $12,000Example: Annual subscription paid in advance.
Prepaid Expenses
Payment made before expense is incurred:
Debit: Prepaid Insurance (Asset) $6,000
Credit: Cash $6,000Example: Six months of insurance paid upfront.
Why Accrual Accounting Matters
Accurate Profitability
Matching revenue with the expenses that generated it shows true profit:
- December project revenue matched with December labor costs
- Not distorted by timing of cash flows
Better Decision Making
Accrual-based financials support:
- Accurate trend analysis
- Meaningful period comparisons
- Valid profitability metrics
Required by Standards
GAAP and IFRS require accrual accounting for:
- Public companies
- Companies seeking investment
- Organizations above certain size thresholds
Bank and Investor Requirements
Lenders and investors expect accrual-based financials:
- Consistent with industry standards
- Comparable to other companies
- Reflects economic reality
Month-End Accruals
Common accruals recorded at period-end:
Accrued payroll: Wages earned but not yet paid Accrued interest: Interest incurred but not yet paid Accrued utilities: Services consumed but not yet billed Accrued revenue: Services performed but not yet invoiced Depreciation: Asset value consumed during the period Bad debt: Estimated uncollectible receivables
Accrual Accounting Challenges
Estimates required: Accruals often require judgment (bad debt, warranty reserves)
Timing complexity: Determining when revenue is earned or expenses incurred
Reversal management: Accruals must be reversed when actual amounts are known
Reconciliation: Accrual entries must be tracked and cleared
Cash flow disconnect: Profitable on paper but cash-poor is possible
How Go Fig Supports Accrual Accounting
Go Fig helps manage accrual processes:
Automated accruals: Generate recurring accrual entries based on rules
Reversal tracking: Ensure accruals are properly reversed
Period comparison: Compare accruals across periods to identify trends
Cash vs. accrual: Reconcile accrual-based results to cash flow
Accrual analysis: Surface accruals that may need adjustment
Audit support: Document accrual methodologies and calculations